Taxes in Retirement

Taxes are an inescapable fact of life, and for those who are preparing to retire or have already left the workforce, those taxes can put a painful dent in their retirement income. Fortunately, there are a number of ways to trim your taxes and keep more of your hard-earned money in your pocket, whether retirement is years away or you are already enjoying your golden years.

Contribute to a Roth IRA

Contributing to a Roth IRA ahead of your retirement is one of the simplest and most effective ways to reduce your tax burden. Unlike a traditional IRA or 401(k), the money you put into a Roth IRA is taxed before contribution, in exchange for coming out tax-free during retirement. Because you are likely in a lower tax bracket when you are just starting to save for retirement, paying taxes at that time, instead of after you retire, can save you thousands of dollars.

While most people will be very well served by investing early in a Roth IRA, there is one major exception. If your employer provides matching 401(k) contributions, you should always aim to contribute the maximum amount they will match before investing the rest in an IRA.

Open a Health Savings Account

If you have a high-deductible health insurance plan, opening a health savings account, or HSA, is one of the smartest post-retirement financial moves you can make. In an HSA, money is contributed pre-tax, enjoys tax-deferred growth and can be withdrawn tax-free as long as the money is spent on qualifying health care. Since medical costs make up a large portion of most retirees’ budgets — even for people in excellent health — opening an HSA is virtually guaranteed to trim your tax bill.

Reduce Your Expenses

Because money taken out from most retirement fund sources, such as traditional IRAs and 401(k)s, is taxed upon withdrawal, cutting down on your expenses after retirement is a sure-fire way to cut your taxes as well. If possible, create a financial planning strategy that involves paying off your mortgage before you retire. Getting rid of your largest monthly expense significantly cuts down on how much you need to withdraw from your retirement fund. Additionally, since you are likely

to be paying off principal on your mortgage rather than interest by the time you retire, the mortgage interest deduction isn’t nearly as beneficial.

Consider Proportional Withdrawals

Many financial consultants advise recent retirees to withdraw money from taxable accounts first, followed by tax-deferred accounts and, finally, tax-free accounts. While this approach can certainly work, and has the benefit of paying much lower taxes during the beginning and end of your retirement years, it also leads to a large “tax bump” once you transition from taxable to tax-deferred withdrawals.

The alternative is to use a proportional withdrawal approach, where you take a portion of the money for your monthly costs from all of your retirement accounts at once. The benefit of this approach is a more stable tax burden across the length of your retirement, longer-lasting savings and lower overall lifetime tax payments. Proportional withdrawals aren’t ideal for everyone; however, if you have multiple kinds of savings accounts and a relatively steady retirement income, it can be an excellent tool for cutting tax costs.

Time Your Investment Sales Wisely

A simple method for trimming your taxes in your golden years is to time the sale of your investments, whether they have earned or lost money. If your stock holdings experience significant growth and you don’t consider it a volatile investment, it would be wise to sell them during a year that your overall income is lower so that you pay taxes in a lower bracket, as well. Conversely, if you are looking to sell off under-performing stocks, realizing losses in an otherwise high-income year can also translate into tax savings.

Donate From Your IRA

Once you have reached 70 1⁄2 years old and have to start withdrawing money from your traditional IRA, it is worthwhile to consider making charitable donations

directly from that IRA. Not only does this ensure that the charity you choose receives the amount of your donation in full by avoiding federal taxes, it also counts toward your IRA’s minimum distribution requirement, up to the $100,000 annual limit, all while being excluded from your adjusted gross income.

Your retirement years are meant to be enjoyed. The last thing you should have to do is worry about whether taxes are impacting your financial security or eating into your savings. By applying the strategies above, you can significantly reduce your tax burden after you retire, even if you are playing catch-up on your retirement planning.


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