By Oscar Casas, CFP®, CRPC®, MPAS®, ABFP℠
When you pause to imagine your retirement as you look forward to the next phase of life, taxes might not be the first thing on your mind. Typically, people start considering taxes around the month of February, and once they file their returns, they often push taxes out of their thoughts entirely.
However, if your goal is to reduce your tax burden in order to help preserve your wealth, it’s crucial to keep taxes in mind throughout the year. This becomes especially important during the retirement stage when you’re drawing down your accounts instead of adding to them. Let’s explore 5 strategies to help reduce your taxes in retirement so you can keep more of your hard-earned money.
1. Utilize Roth IRA Conversions
Distributions from Roth IRAs are tax-free, so they are a great tool to have in retirement. However, many people cannot contribute directly to a Roth IRA because of income limitations. Instead, you could convert traditional IRA funds to a Roth account by paying the related income taxes. You can take advantage of low-income years, to convert your funds to a Roth IRA so you’ll have tax-free income later. It is important to be mindful of tax brackets when you do conversions so you don’t inadvertently push yourself into higher tax rates.
2. Be Strategic About Inherited IRAs
At the beginning of 2020, the laws surrounding IRAs inherited by non-spouses changed. You no longer have to take out a specific amount of money from the account each year, but you do have to empty the account within 10 years. If you fail to be strategic about withdrawals, you could be forced to empty the entire account at once with 10 years’ worth of growth. The problem with that is it would greatly increase your taxable income for the year, pushing you into higher tax brackets and subjecting you to added taxes, like the Medicare surcharge tax. If you inherit an IRA from someone other than your spouse, you need to be strategic about your withdrawals and time them so as to limit your tax liability.
3. Limit Your Exposure to the 3.8% Medicare Surcharge Tax
There is a 3.8% Medicare surcharge tax that applies to net investment income for singles with a modified adjusted gross income (MAGI) of over $200,000 and couples with a MAGI over $250,000. (The MAGI is adjusted gross income with some deductions added back in.) The surcharge tax is due on the smaller of net investment income or the excess of MAGI over the thresholds. If your MAGI is near or above the thresholds, there may be steps you can take to limit your exposure.
4. Take Advantage of the 0% Rate on Long-Term Capital Gains
If the Medicare surcharge tax is irrelevant to you because your income is lower, then you may be able to take advantage of the 0% long-term capital gains rate. Profits on the sales of assets owned over a year are tax-free if your income is below $47,025 for singles or $94,050 for married couples filing jointly. Once you exceed those thresholds, long-term capital gains are taxed at 15% or 20% depending on your income.
Claiming more deductions or making deductible IRA contributions can help keep your income within the 0% capital gains tax range while also providing their usual tax benefits. However, you will want to be strategic about taking tax-free gains as they can raise your adjusted gross income and affect the taxability of your Social Security benefits. Also, taking those gains may incur state tax liabilities as well.
5. Donate Effectively
If you are charitably inclined, one of the best ways to save on taxes is through donations. In some instances, you can get a tax deduction on donations up to 60% of your adjusted gross income. If you have appreciated assets, you can get an even greater tax break. When you donate an appreciated asset that you have owned for over a year, such as stocks, to a charity, you do not have to pay capital gains taxes on the appreciation, but you still get to claim the full value for your deduction. This allows you to avoid the capital gains tax altogether. If your assets have declined in value, it is best to sell them yourself and donate the proceeds so you can claim the loss when filing your taxes.
Another strategy to consider is the use of a charitable lead annuity trust or a donor-advised fund, which allow you to take an up-front write-off that can help offset other income, such as from a Roth IRA conversion or withdrawal from an inherited IRA.
Create a Custom Strategy
Minimizing your tax burden in retirement is possible through strategic steps, but like many tax-related things, it involves various factors that demand careful consideration for an effective plan that saves you money. The good news? You don’t have to tackle this process on your own. If you’re considering these tax-saving strategies, teaming up with an experienced financial advisor can make all the difference.
If you haven’t yet found a trusted advisor, I’d be delighted to chat with you about how our team at Tranquility Path Investment Advisors can offer assistance. Our mission is to help you feel confident in your retirement plan knowing we’re always looking at the big picture. Schedule an introductory meeting online or reach us at (732) 856-4324.
About Oscar
Oscar Casas is the chief executive officer at Tranquility Path Investment Advisors, an independent Registered Investment Advisor firm dedicated to putting their clients first, always. Oscar has over a decade of experience helping clients plan for a confident retirement. He is known for being an empathetic and compassionate listener and for prioritizing his clients’ needs and goals above all else. He acts as a coach, advising his pre-retiree and retiree clients through all the ups and downs on their financial journey. He loves that he has the opportunity to make a difference in people’s lives and take some of the stress off their shoulders.
Oscar has a bachelor’s degree in finance, a master’s degree in personal financial planning, and is a CERTIFIED FINANCIAL PLANNER™, Chartered Retirement Planning Counselor℠, Master Planner Advanced StudiesSM and Accredited Behavioral Finance Professional℠ professional. When he’s not working, you can find him enjoying the outdoors with his three children. He is an avid tennis player who also loves golf, the beach, snowboarding, traveling, and volunteering with the Scouts.
