7 Ways to Reduce Your Taxes in Retirement

7 Ways to Reduce Your Taxes in Retirement

So let’s get started. Today, we're talking about Tax Planning, a crucial aspect of retirement planning that can greatly impact your retirement. Tax Planning should be a big part of your retirement plans. While taxes generally decreases in retirement, it is still a large expense. Making a major mistake regarding taxes could substantially throw off your retirement success.

 It is important that you can anticipate your taxes for the next 20 to 30 years. At Capital Wealth Group, we create projections for each client, estimating their annual tax payments each year for a short-term view and long-term view over a 30 year period . This projection is constantly being updated and maintained to ensure we are as accurate as possible.

During your working years, as W2 employees taxes are often deducted from each paycheck. This way you don’t have to worry about paying too much or too little come April.

Similar withholding can be arranged for your pension, Social Security, annuity, and other retirement income through forms W-4, W-4P, and W-4V.

If you're not opting for automatic withholding on taxable income, you'll likely need to make quarterly estimated tax payments. The IRS offers very detailed instructions on their website on  Tax Withholding and Estimated Tax. Or you can use Form 1040-ES to estimate your payments. See links to these sites below.

1. Income Withdrawal Sequences 

As you approach retirement, deciding how to withdraw funds from your retirement accounts can greatly affect your tax situation. While starting with taxable accounts is a common approach, keep in mind that taking some money from your IRA or 401(k), before RMD age may be more tax efficient. It depends on your account balances. If you have over a million dollars in IRAs/401ks, it could be beneficial to begin withdrawals before the Required Minimum Distribution (RMD) age. The only way to truly figure

out the optimal withdrawal sequence is to input all your information into a retirement planning software and run various scenarios.

2. Asset Location

Another way to be tax efficient is called "asset location." This means placing investments with higher expected tax obligations, such as bonds or high-dividend stocks, in tax-advantaged accounts. You might put more weight on equities with growth potential in taxable accounts. This way, you might reduce taxable interest and dividends, all while letting your investments grow more efficiently. However, if you plan to tap into your taxable account first, consider not placing all your stocks there and having some short-term bonds that you can withdrawal during down markets.  This can be accomplished by simply rebalancing but you would need some bonds or bond funds to do this. So let me be clear, in general, you want bonds and dividend paying stocks and funds in IRAs and 401ks, in general, you want a higher percentage in growth stocks and growth investments in Roth IRAs and traditional taxable accounts. And another way to put it you want tax efficient investments in your taxable accounts and growth investments in Roth IRAs, and a higher percentage of  investments the produce high taxable income in IRA’s and 401ks.  Of course, you want to make sure your overall asset allocation meets your risk tolerance, needs, and time horizon.  

Roth Conversions

Roth conversions can be a powerful tax planning tool for some. In general, consider Roth Conversions after retiring, but before Social Security or a pension kicks in. If you've got taxable savings, you can live off those post-tax funds for a few years, which will create very little taxable income. During this period of low taxable income, explore Roth conversions. Even after starting Social Security, conversions can make sense, though they become less appealing.

Converting from a traditional IRA or 401(k) to a Roth account is a strategic move. You'll pay taxes on the converted amount, but the Roth's future growth can be withdrawn tax-free. When to convert can be perplexing.

Calculations involving current and future tax brackets, return rates, withdrawal needs, and more come into play. A simple approach is comparing your current and projected tax brackets. And a common rule of thumb is thatthose in lower (10% and 12%) federal tax brackets should consider Roth conversions, while higher brackets (32%, 35%, and 37%) may not want to do conversions.

4. Tax Loss Harvesting with ETF’s

The 4^th way Selling investments from non-retirement accounts can come with capital gains taxes on the profits you've earned. But, here's the kicker: if you've sold some investments at a loss within the same year, you can use those losses to offset the gains and dodge those taxes.

So, tax loss harvesting is about smartly selling investments that have lost value to offset capital gains. But there's a catch, the wash-sale rule says you can't buy a “substantially identical” investment within 30 days before or after the sale. Got it? It's like a 61-day window. But, here's the trick: you can actually dodge this rule using similar ETFs.

Let's say you own Vanguard S&P 500 ETF (VOO) with a 10% unrealized loss. You sell VOO, deduct that loss, and instantly buy iShares S&P 500 ETF (IVV), when the S&P 500 index is at the same level. So, you're pretty much taking a loss, locking it in, and staying in the market. That means if you've also sold another investment for a similar gain, you can balance it out with the loss, not pay any capital gains, and still own S&P 500.

This strategy can really help reduce your taxable income. But, be cautious, though, as tax rules dictate how losses can be used. Yet, with proper planning, you could potentially turn market downturns into tax-saving opportunities.

Tax loss harvesting lets you drop the investments that aren't doing great while getting a little benefit from the deal. In fact, if your losses outweigh your gains, you can use the extra losses to wipe out up to $3,000 of other taxable income.

5. Medicare Premium Surcharges 

Now, as you plan for retirement, make a mental note about potential Medicare premium surcharges. These sneaky charges can hitch a ride onto

your Medicare Part B and Part D premiums. They hitch a ride based on your "modified adjusted gross income" or MAGI.

Let's break it down: In 2023, a Medicare surtax, IRMAA, gets slapped on the high-earners. If you're flying solo, that's $97,000, and if you're sharing life's journey, that's $194,000. This threshold keeps adjusting by inflation, year by year. So, staying under these thresholds might be worth the effort. 

6. Charitable Donations: 

Now, think about a twist in your charitable game. Instead of giving annually, try bundling. Think 2, 3, or even 5 years' worth of donations in one shot, then take a breather. This shift skyrockets your deductions beyond the threshold for that single year, and in the break years, you go for the bigger standard deduction.

Want a cherry on top? A Donor-Advised Fund (DAF) could be your ally if you're bundling charity. It’s like making tax-deductible contributions of cash or appreciated assets in one year, but then control when those donations flow to charity anytime in the future.

7. Plan for Required Minimum Distributions

According to the IRS, a required minimum distribution is the minimum amount you must withdraw from your tax advantaged savings accounts each year.

You can also donate part or all of your RMD directly to your charity of choice. If you are already giving to a charity or your church this is a no brainer. You will not have to pay taxes on the RMD that you donate and your charity doesn’t have to pay taxes either. This is another way to get around the large deduction threshold.  if you don’t

You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA or other retirement plan account if you have reached age 73. The RMD age has been raised to 73 starting in 2023 and it will be 75 in 2033. Roth IRAs do not require withdrawals until after the death of the owner.

If you do not make these withdrawals, the IRS will assess a large penalty of 50% of the amount that should have been withdrawn.

The IRS has more information on Required Minimum Distributions (RMDs).

Conclusion

In conclusion—some pretty powerful strategies to reduce taxes in retirement. By carefully planning your income withdrawal sequences, optimizing asset location, considering Roth conversions, utilizing tax loss harvesting, keeping an eye on Medicare premium surcharges, and being strategic about your charitable giving you can make the most of your retirement savings and achieve your financial goals with confidence.  Taxes can be a burden, but they are just one of hundreds of expenses we all contend with.

Having a well documented overall retirement plan can help insure that none of these and other tax saving strategies fall through the cracks.

And next week, I will be educating you on Roth Conversions. 5 scenarios where a Roth conversion might be a good idea.