Money Management

Don’t take withdrawals from your retirement accounts without understanding this first. 

When it comes to funding retirement, most Americans turn to their pre-tax accounts. 401(k)s, 403(b)s, and IRAs are popular savings vehicles and account for the bulk of pre-tax retirement savings among Americans. However, withdrawing from these accounts could spring a series of traps, commonly referred to as stealth taxes. What are common stealth taxes and how do they work? Read on to learn more.

Read more: The Ascent’s complete guide to taxes

Higher marginal tax rates

The basis of stealth taxes is this: withdrawals from pre-tax savings accounts count as taxable income. This nuance can send unexpected shock waves through your retirement plan. The most obvious of these is in the form of income tax brackets.

Pre-retirement savings are very common among Americans — and for good reason. Deferring your income on a pre-tax basis into an employer retirement plan, such as a 401(k) or 403(b), or into an individual retirement account, yields two major benefits. First, savers build an asset base which can be drawn from in retirement. Second, a saver’s income is reduced by the amount of their contribution in the year in which they contributed. The complications come into play when you draw down these assets in retirement.

The government, at the state and federal level, wants to encourage Americans to save for retirement, so do not tax money contributed to qualified retirement accounts. However, the government is not willing to forfeit their tax revenue entirely. While contributions to pre-tax retirement plans are not taxed, all withdrawals from these accounts, including both contributions and earnings, are fully taxable. So those in retirement should anticipate paying taxes, even though they may not have traditional earnings in retirement.

Social Security tax

Many retirees view Social Security as an integral piece of their retirement plan. However, not every Social Security recipient recognizes that their benefits may incur a tax liability. And if you aren’t careful, your retirement account withdrawals could lead to more of your Social Security benefits being taxable.

Part of your Social Security income may be taxable depending on your combined income. Your combined income is a metric used by the Social Security Administration, and factors in your adjusted gross income. If your combined income is below $25,000 for individual taxpayers or $32,000 for joint filers, none of your Social Security benefits are taxable. Should your combined income exceed that, up to 85% of your benefits may be taxable, subject to certain thresholds.

Recognizing a larger portion of your Social Security benefits as taxable income is a common stealth tax. When you withdraw assets from your pre-tax retirement accounts, you must count those assets as taxable income. And if that additional income puts you over the threshold to be taxed on your Social Security benefits, the difference could potentially be thousands of dollars in tax liability.

Medicare premiums

Medicare is another government program commonly used by retirees. While Medicare Part A, commonly referred to as hospital insurance, is free of cost for most people, certain Medicare benefits come at the price of a monthly premium. This premium is not the same for everyone — those recognizing higher income may have to pay more every month for the same coverage.

Both Medicare Part B (medical insurance) and Part D (drug coverage) charge retirees monthly premiums. While many retirees pay a standard premium for these coverages, those with higher income may be subject to a surcharge. Income Related Monthly Adjustment Amount, or IRMAA, may increase your monthly premium based on your modified adjusted gross income and how you file taxes.

As stated above, withdrawing from a pre-tax retirement account raises your taxable income. This higher reported income could lead to paying higher premiums for Medicare Part B and D coverage. While the vast majority of people will not be subject to IRMAA, the highest IRMAA surcharge could see you paying a premium of nearly 3.5 times the base premium.

By understanding the implications of stealth taxes, you can optimize your retirement income plan. Recognizing that pre-tax savings are taxable income is a good first step, but you should also recognize that this income may have ripple effects when it comes to how your Social Security benefits are taxed and how much you’ll pay for Medicare coverage. Stealth taxes in retirement may be costly, but they are far from inevitable for the knowledgeable retiree.

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It’s a risky move that could really backfire on you these days. 

Some people buy fixer-uppers thinking they’ll renovate and create their dream homes. But you may be motivated to buy a home that’s not in such great shape so you can fix it up and sell it at a profit. It’s a concept known as house flipping, and it’s something some investors actually do for a living.

House flipping comes loaded with potential risks, though. If it costs more to renovate a home than expected, you may not profit, but end up losing money. And also, people who flip houses for a living often finance those purchases with cash, not a mortgage loan.

Signing a mortgage requires you to pay closing costs, which can equal 2% to 5% of the loan amount you take out. Those costs will eat into your profit if you then try to flip the house you’re selling, so often, house flippers find other ways to round up capital, whether by coming up with cash or taking out hard money loans (short-term loans that carry their share of risk).

But these days, you may be taking on an even bigger risk than usual by purchasing a home to flip. That’s because as of the third quarter of 2022, house flipping profits were down 11.4% from the same time last year, according to ATTOM, a provider of real estate data.

House flipping profits were also down 18.4% during the year’s third quarter compared to the second. And last quarter’s profits were also the lowest for house flippers since the end of 2019. So if you’ve been thinking about jumping into your first house flip, you may actually want to reconsider.

A bad time to try to turn a quick profit

Over the past few months, home price gains have slowed down and buyers have slowly pulled out of the real estate market. This isn’t to say that the market has crashed. Quite the contrary — buyer demand is still strong, and there’s still more demand to purchase homes than there is available supply of them.

But even so, rising costs are making it harder for house flippers to profit. And that’s within the context of many house flippers being experienced at renovating homes. So if you’re a newbie trying to fix and flip a home, you might really run into financial issues that make you regret your decision.

The right way to buy a fixer-upper

You may decide that since housing supply is limited, you’re going to purchase a home, renovate it, and then live in it yourself. That’s not necessarily a bad move. In that situation, you’re not looking to turn a quick profit. Rather, you’re making an investment in a property that you’re planning to hold onto.

Through the years, your home might appreciate in value quite nicely. And even if it doesn’t appreciate at the rate you’re hoping for, you’re still getting a roof over your head. So while buying a house to fix and flip isn’t necessarily a smart move right now, if you’re willing to take on the work of a fixer-upper, you may find that doing so makes it possible to become a homeowner and end up owning a place you’re happy with.

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Your 30s are the time to start making moves financially. 

As you enter your 30s, that’s often when things start trending up financially. You might find yourself earning more money than you did when you were younger, getting more established in your career, and being able to build your savings.

Since your situation has changed, your goals should, as well. If your 20s were about laying a foundation, the next decade is all about growth and putting yourself in a comfortable position going forward. To achieve that, here are five personal finance goals for 30-year-olds.

1. Increase your income

Ideally, your earning potential increases as you get older. You have more experience, and you develop more skills. That’s why your biggest priority in your 30s should be to maximize your income. Set realistic but ambitious goals, like earning another $5,000 to $10,000 next year.

The best way to do this is going to depend on your skillset and your current employment situation. Here are some different options to consider:

Let your employer know that you want a raise and ask what you can do to advance.Try job searching to see if you could get a higher salary from a new employer.Start a small business or start working for yourself as a freelancer.Check out side hustles that could fit your schedule and help you bring in additional income.

2. Pay off high-interest debt

Saving money while you have high-interest debt is kind of like running a 5K with ankle weights. Sure, you can do it, but it’s going to be much harder. Those monthly debt payments cut into what you can put towards your savings goals and retirement.

Where a lot of people have trouble is credit card debt, since it’s easy to overspend with credit cards. If that’s an issue for you, focus on getting out of credit card debt and avoiding it going forward. And if you have any other debt with high interest rates, like payday loans, make sure to attack those, too.

Low-interest debt normally isn’t a big deal. If you have a reasonable auto loan or a mortgage, you don’t need to pay those off ASAP — although you can if you want.

3. Save one year’s salary

Many personal finance experts recommend saving at least one year’s salary by the time you’re 30. If you make $50,000 per year, then your goal would be $50,000.

To clarify, this doesn’t mean you need all that money in just your savings account. You can include the money in all the bank accounts, retirement plans, and brokerage accounts you have.

This can be a challenging goal, and a lot of 30-year-olds don’t have a year’s salary saved. If you’re not there yet, make it one of your financial goals to hit during your 30s. You’re going to need several times your annual salary to be comfortable in retirement. One year’s salary is a good starting point you can build on.

4. Get a credit score of at least 760

Your credit score is a measure of your credit worthiness, or how likely you are to repay money you borrow. The type of score that’s most widely used by lenders is your FICO® Score, and it’s on a scale of 300 to 850.

There are quite a few perks of a high credit score. The perk that may be especially important to you at this stage of life is that your credit score determines your mortgage rate. If you’re planning to buy a home, improving your credit score could save you $10,000 or more over the lifetime of a mortgage.

Consumers with a FICO® Score of at least 760 get the lowest mortgage rates, so that’s a good target to aim for. Even if you don’t plan to buy a home, your credit score could also make it easier to get approved for an apartment and open one of the top credit cards, among many other financial perks.

5. Save 20% to 30% of your income

Saving money consistently allows you to be prepared for large expenses and put money away for retirement. When you were in your 20s, saving 20% to 30% of your income may not have been feasible. Money’s often tight in that age bracket.

In your 30s, it’s really important that you save a solid chunk of your income. You don’t want to play catch-up with your retirement savings in your 40s and 50s. It’s stressful, and when you’re closer to retirement, your money has less time to grow. That means you need to save even more than you would’ve if you had started now.

Start saving at least 20% of your income if you aren’t already. If you can save more, that’s even better. As far as where to put that money, divide it between your savings and your retirement accounts. You can do an even split or weigh it more heavily towards one or the other, depending on your current priorities.

Your 30s could be a decade of exciting financial developments. Achieving the goals listed above will help you stay on track and put you in a great position for the years to come.

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We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Lyle Daly has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy.

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You should read this Graham Stephan advice before you buy a home. 

Buying a house is usually a smart financial investment. When you’re a homeowner, your monthly payment helps you acquire equity so you eventually pay off your loan and own a valuable property free and clear. Ideally, you will also see the value of your home increase over time, which means your house provides not just a place to live but also a way to grow your net worth.

But, if you’re buying a house right now, you’re facing some challenges. One issue is that mortgage rates are higher than they have been in years, and another is that there’s a possibility of a housing market crash following a buying frenzy during the COVID-19 pandemic.

This does not mean you shouldn’t purchase a property. But you need to be smart about it. Real estate investor, finance expert, and YouTube Personality Graham Stephan recently offered some important advice on what you should do to make the most of your purchase if you’re thinking of buying now.

This is crucial if you’re considering buying a house now

Stephan advised that you should buy a property now only under one condition. You can make the most out of your purchase and do the most to protect your investment dollars if you buy a house only if you plan to keep it for the long term.

“Buy property only if you are planning to keep it for 7-10 years,” Stephan advised. He explained that he believes it is important to invest in real estate now only if you have a long timeline because the housing market is very speculative right now.

If you buy a home for the long term, you won’t have to worry as much about your investment losing value. While the real estate market does decline during certain periods of time, it tends to correct itself eventually and so you will see housing prices go back up over a long enough time horizon.

If you’re expecting to sell your home pretty soon after buying, you might find yourself not able to make back what you pay for it — especially after covering the cost of closing fees and mortgage interest paid at today’s high rates. But if you hold onto your home for at least seven to 10 years, odds are that property values will have recovered from any coming downturn and you should be able to make money on your investment.

Is Stephan right?

Stephan is spot on in suggesting that you shouldn’t buy a house now if you intend to sell it very soon. There is a lot of uncertainty in what home prices will do both because prices were up a lot during the pandemic and because high mortgage rates could cause demand to fall in the short term.

In general, homes are not very liquid investments and they can take a long time to sell. They also come with lots of transaction costs both when you buy and sell. So buying only when you have a long time horizon is always good advice — but it may be more important now than ever to think about your future plans and make sure you’re comfortable staying put for a while.

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Sometimes, you have to know when to call it quits. 

It’s hard to believe that 2023 is almost here. But at this point, a lot of people are busy finalizing their holiday plans and figuring out what they’ll do on New Year’s Eve. (Pajamas, movies, and books, anyone? Or is that just me?)

Now is also the time when a lot of people start setting their New Year’s resolutions. And if you have financial goals you want to achieve in 2023, that’s certainly not a bad thing to do.

In fact, I like to make a habit of setting a few financial goals at the start of the year. And in the past, I’ve been successful at some of them.

Years back, for example, my goal was to max out my retirement plan contributions, which sure enough, I did. Another year, I pledged to boost my emergency fund by several thousand dollars, and lo and behold, I closed out that year with a higher savings account balance.

But there’s one thing I’ve resolved to do over the past five years that I’ve never managed to uphold. And so at this point, I think it’s time to give up and focus on other ways I can improve my financial picture.

I can’t shake my takeout habit

In the past, I’ve pledged to order less takeout for a couple of reasons. Not only is it more expensive than buying groceries and cooking, but it can also, in some cases, be a lot less healthy.

But for the past number of years, my efforts to cut back on takeout have been futile. For one thing, I have a pretty hectic schedule. I work full time, volunteer, and have three small humans to parent. I also have a lovable but demanding dog who requires several walks a day and lots of attention. So all told, I just don’t have that many hours in my day to hang out in my kitchen and cook. And often, I need to fall back on takeout due to a lack of time.

Also, my kids, like many kids, are picky. So sometimes what’ll happen is that I will make the effort to cook, only to end up having at least one child refuse to eat what I’ve prepared. Takeout solves that issue because we can order different items off of the same menu.

And finally, because I’m self-employed, the more I work, the more I can earn. If I don’t have to spend several hours each week shopping for food, cooking, and cleaning up my kitchen afterward, I can spend more time hammering away at my desk. And as such, I can actually justify the cost of takeout to a large degree.

I won’t set myself up for failure

As much as I’d like to say I’ll order less takeout in 2023, that probably isn’t in the cards. And I’m really okay with that.

The way I see it, there are other expenses I can seek to cut if doing so becomes necessary to meet my financial goals. But I don’t feel compelled to cut back on the one luxury that makes my life much easier, addresses picky eater issues, and puts delicious food in my belly.

As far as the health aspect goes, I can address that by aiming to order healthier, veggie-packed meals more often, and cutting back on things like pizza and burritos. But all told, I won’t be resolving to do anything that involves ordering takeout less frequently.

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Be sure to take advantage of this crucial decade. 

Many people spend their 20s saving money to buy a home and trying to work their way out of debt. And because 20-somethings are, by nature, new to the workforce, they often don’t earn the highest salaries.

That’s why a lot of people in their 20s don’t focus on investing — they have other priorities to think about, and understandably so. But if your goal is to attain financial freedom and security, then Suze Orman insists that it’s important to take advantage of your 20s — and start investing then.

Don’t pass up a key opportunity

When you’re first starting out in your career and your earnings are limited, it can be difficult to eke out money to invest in a brokerage account or IRA. But on a recent podcast episode, Suze Orman made a point to talk about why 20-somethings should make an effort to invest.

Specifically, Orman said, “It is so important in my opinion that we all become what I call the ultimate savers and investors. And I have to say that one of the best ways to do that is to start saving and investing more at an early age than you do even at a later age. Because of compounding.”

“The key to true financial independence and freedom starts when you are in your 20s, when you are in your 30s. Because every dollar that you invest gets to earn money. Then the earnings of that money gets to earn money. And then over all the years, your money compounds. And you will have more and more money.”

Orman is totally spot-on. Let’s say you invest $1,000 in your 20s. After a year, the $1,000 in your IRA or brokerage account balance might grow to $1,050. But then the next year, you’re not just earning a return on your initial $1,000 investment. Rather, you’re getting to invest your $1,050 and earn a return on that sum. So all told, through the years, the more your portfolio balance grows, the more money you have to invest and earn money on.

In fact, let’s say you assemble a portfolio of stocks or exchange-traded funds that delivers an average yearly 8% return, which is a bit below the stock market’s long-term average. If you invest $10,000 at age 25, by age 65, you’ll end up with about $217,000, even if you don’t put another dime of your own money into your brokerage account or IRA during those 40 years. Rather, that $207,000 gain will come as a result of compounded returns.

But watch what happens if you wait 10 years to make that $10,000 investment. At that point, you’ll be looking at around $101,000 after 40 years. Now, that still means you’re walking away with 10 times your initial investment, so that’s not a bad deal. But it’s not the same gain you would’ve enjoyed had you started investing in your 20s.

Advice worth taking

Even if money is tight in your 20s, it still pays to do what you can to allocate some cash to investing. And it doesn’t have to be a lot. You can invest $100 your first year if that’s all you can manage. But that way, you’ll at least start putting your money to work so you can take advantage of the power of compounding. And that could lead to a world of financial freedom down the line.

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We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

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