3 Simple Ways to Lower Your Taxes in Retirement

Posted by Don on March 22, 2017

Wouldn’t it be great to not have to worry about taxes during retirement? As great as that sounds, the reality is you are going to be paying taxes until the day you pass away. As the old saying goes, the only two certainties in life are death and taxes.

But what taxes will you pay? Are there any ways to lower your taxes in retirement?

lower your taxes in retirement

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3 Ways to Lower Your Taxes During Retirement

Luckily there are some strategies to help you save money on taxes. I am going to walk you through 3 things you can do to help lower the amount of tax you pay. But before you run out and start doing any of these things, make sure you speak to both your investment advisor and your tax accountant to make sure they make sense for your personal situation. The last thing you want to do is pay more taxes now or worse, make a move that will cause your retirement nest egg to not provide enough income for you through your golden years.

  1. Convert to a Roth IRA

    When you have money in a traditional IRA or a 401k plan, the tax law states you must start taking withdrawals once you reach age 70 ½. And since your contributions to your traditional IRA and 401k grew tax deferred, this means you will be paying taxes every year on these required distributions.

    On the other hand, there is the Roth IRA. With a Roth IRA, you make contributions after-tax, meaning that when you withdraw the money, you don’t pay any taxes. Plus, you aren’t required to take the money out when you reach a certain age. If you wanted, you could never touch the money and will it to your children or grandchildren.

    An option is to convert some or all of your traditional IRA or 401k plan balance over to a Roth IRA. You should do this before you reach 70 ½ years old so you don’t have to bother with required minimum distributions. The catch to this is that you will have to pay tax on the amount you convert.

    You might be wondering how this will lower your taxes in retirement. If you expect to be in a higher tax bracket at retirement, then doing this can make sense for you and save you money on taxes. For example, let’s say that your spouse still plans on working part-time and with your required minimum distribution and Social Security you will have taxable income of $80,000. That puts you in the 25% tax bracket (depending on how much of your social security is taxed). But right now, before you are taking your required minimum distribution, you have $50,000 of taxable income. This means you are only in the 15% tax bracket. Paying the tax now on a conversion could be less than the future tax on a required distribution.

    Again, you should talk to your tax accountant to understand where you stand now and where you will stand if you were to not convert and get taxed on your required distribution amount. For some, paying the tax now could mean a tax savings. Also see Should you do a Roth Conversion?

    And one final point if you do decide to go this route. Don’t use your retirement funds to pay the taxes due. Use any cash you have sitting on hand to cover the tax bill. The more money you keep in your retirement account, the more compounding and growth can occur.

  2. Donate to Charity

    We all know that donating to charity is a good thing. And doing so can also lower your taxes in retirement. Let’s assume making a conversion to a Roth IRA is not for you. You can instead make a qualified charitable distribution from your IRA.

    This means that instead of receiving the cash from a required minimum distribution, you can just donate the money instead and get the tax write off that it provides. In many cases, your investment custodian has the paperwork to do this so the process is easy.

    On the other hand, if you are making the conversion to a Roth IRA, you can still reduce the taxes on the conversion by making a charitable donation during the same year. The only catch here is that the donation has to come from outside a retirement account. Since you are simply moving from a traditional IRA to a Roth IRA, the donation cannot come from this account. But making a sizable donation can help to offset some taxes that you would otherwise owe.

    Finally, another option is to donate stocks or mutual funds you have in a taxable account to charity. In this case, you can simply donate the appreciated asset to the charity of your choice. The reason for doing this is that you can avoid paying any capital gains tax if the stock appreciated in value and take a charitable deduction. Reader Mark points out:

    Any big gains can be directly donated to a favorite charity rather than selling it to get the double benefit of a charitable deduction and the avoidance of capital gains. To me, that is one of the biggest tax benefits of investing since a double benefit is realized.

    There is a limit to how much you can donate when it comes to appreciated assets, so be sure to talk things over with your tax accountant.

  3. Take Retirement Withdrawals Sooner

    A final option for you to lower taxes in retirement is to start withdrawing money from your traditional IRA account once you reach 59 ½ years old. By taking withdrawals at this age, you accomplish a couple of things.

    • You lower your future required minimum distribution amount. Your RMD is based on your age and account balance. By having a lower account balance, your future RMD will be lower and thus you will pay fewer taxes.
    • You can put off taking Social Security. By waiting to take Social Security benefits, you will receive a larger benefit. The catch here is that once you reach your maximum social security age, your benefit will not grow any longer, so it makes sense to begin taking it at this time.

    Of course, as with the other options listed, you need to talk things over with your tax accountant to make sure you aren’t pushing yourself into a higher tax bracket now, just to save money on taxes later. Once you withdraw the money see What to Do With Your Required Minimum Distribution.

Final Thoughts

While taxes are inevitable, you want to make sure you lower your taxes in retirement. This is because many things like the tax you pay on Social Security benefits and your Medicare premiums are all tied to your income. The more income you have in retirement, the more taxes you pay and in the case with Medicare, the higher the healthcare premiums you will pay.

Take the time to sit down with your accountant and walk through various scenarios. Ideally, your financial picture in retirement will be a simple one and you won’t have to take any steps to ensure your taxes are minimized. But in the event you do have to take steps, these 3 options are worth looking into.

What suggestions do you have to lower your taxes in retirement?

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