Navigating Retirement and Taxation: Strategies to Minimize Taxes

by: Jeremy Reif, CRPS

Retirement is different for everyone.  The commonality is that retirees face a significant change in their financial landscape.  Minimizing taxes can have one of the largest effects on retirement and is the biggest key to watch. Understanding the tax implications of your retirement income is crucial for maintaining your financial health. This article will explore how income is taxed during retirement, strategies to minimize your tax burden, and tips for staying compliant with IRS rules.

Understanding How Retirement Income is Taxed

As people go through life, they learn about finances differently.  Not all lives are created equal, nor do they receive the same income, or inheritance, take the same risks, or even invest the same.  Therefore, retirement income can come from various sources, each with a different tax treatment.  Below is a list of the most commonly found incomes for retirees:

Social Security Benefits: Many retirees think that during retirement, S.S. is not taxed.  The reality is that the taxation of S.S. benefits depends on your total combined income (your adjusted gross income + nontaxable interest + half of your Social Security benefits). If your combined income is too high, up to 85% of your benefits could wind up taxable on your 1040.

Distributions from Retirement Accounts: Withdrawals from traditional IRAs and 401(k)s are taxed as ordinary income. However, Roth IRAs and Roth 401(k)s offer tax-free withdrawals because contributions are made with after-tax dollars.

Pensions: Many pensions are taxable at your ordinary income rate, although some portions may be tax-free if you contribute after-tax dollars to your Pension.

Non-Qualified Investments: Long-term capital gains from selling investments held for more than a year are taxed at lower rates than ordinary income, while dividends can be taxed at the qualified dividend rate, which is also lower than the ordinary income tax rate.  There is also the ability for tax losses to be written off against income.

Rental Income:  Rental income does not count towards S.S. and can provide both income and potential tax losses.

Passive Income:  Other income might be various forms of residual passive income.

Disability Income: The taxation of disability income depends on a few things.  Was the premium paid for before or after taxes?  For S.S. disability, this is not taxable if your provisional income is not more than your base amount.

Strategies to Minimize Taxes in Retirement

1. Roth Conversions: Converting part or all of your traditional IRA or 401(k) to a Roth IRA can provide tax-free income in retirement. Although the conversion triggers a tax bill, it may be beneficial if you expect to be in a higher tax bracket in the future. This is where number two comes into play, distribution planning. Having an income plan helps tremendously.
2. Distribution Planning: Carefully plan withdrawals from taxable, tax-deferred, and tax-free accounts to minimize your tax liability. Traditional distribution thoughts are to be taken from the non-qualified accounts first, tax-deferred second, and tax-free last. For those that have saved well into their traditional assets, consideration should be given to taking from the tax-deferred accounts first to lower future tax liabilities rather than letting the deferral compound.  Taxes for Roth conversions could be paid by the non-qualified.
3. Tax-Loss Harvesting: This involves selling investments at a loss to offset capital gains in other investments, reducing your taxable income. This is only valid for non-qualified accounts.
4. Manage Required Minimum Distributions (RMDs): Starting at age 73, you must take RMDs from your retirement accounts, which can push you into a higher tax bracket. Forecasts should be made to see whether you fall in this category. Consider strategies like QCDs (Qualified Charitable Distributions) or utilizing donor-advised funds to reduce your taxable income. Roth conversions could be done to reduce this burden before reaching this age.
5. State Taxes: Be aware of the state tax implications for your retirement income. Some states do not tax Social Security benefits or offer favorable tax treatments for retirement income. Other states do not have a state tax on IRA distributions (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming). Do not just up and move to those states, do your research.  Those states have a different way of making up for the taxes they missed out on.

Navigating the tax landscape in retirement can be complex, but with careful planning and strategic decision-making, you can optimize your financial health and minimize your tax burden. Consider consulting with a tax professional or a financial advisor to tailor these strategies to your specific situation. Staying informed and proactive about your taxes in retirement can help you enjoy your golden years with financial peace of mind.

Originally Published on https://pointwealthmanagement.com/blog/

Jeremy Reif CRPS®

Just like the majority of you, family is where it matters most. For me, it all started when I was young. Like many, my parents played a large role in who I am today. I was fortunate enough to have a family that tried to teach me about the world of finances. This is where I feel that the public school systems tend to fail our society; rather than make mistakes with money and try to learn from the mistakes, I was able to avoid them. I was and still am enamored with finances and economics. Maybe it is a Midwest type of thing, as I am passionate about helping others succeed with their own finances. I hope you find my articles and videos as helpful as my clients have.