A large retirement corpus is what everyone aims for, but the tax imposed on this corpus in retirement is often ignored. Your retirement income, although limited, can come from different sources. These can include your retirement accounts like a 401(k) account, an Individual Retirement Account (IRA), Social Security benefits, and other investments like bonds, stocks, mutual funds, real estate, etc. All of these income sources can be taxed depending on their value, withdrawal limits, taxability laws, etc.
You will be surprised to know that up to 85% of your Social Security benefits can be taxed. Traditional 401(k) accounts and IRAs are also taxed. In addition to this, federal income tax, estate tax, state tax, sales tax, etc., can add up to a significant number and reduce your overall retirement corpus. When you add inflation to this, you may be left with even less. Assuming the rising life expectancy rates, there is a significant chance of you outliving your retirement savings if you do not plan your retirement well. However, when you throw in taxes to this equation, your corpus is stretched a lot more. Hence, retirement tax planning becomes crucial. To guide you through this, you may consider consulting with a financial advisor who can answer your queries pertaining to retirement planning. In addition, he can help explain different tax planning strategies that you can use to boost your retirement corpus.
Tax planning strategies for retirees refers to methods to lower the tax output in retirement. These strategies can be applied both before and after retirement to save tax. It is estimated that by the year 2030, all baby boomers would be at least 65 years old. Baby boomers are people born between the years 1946 and 1964. There were an estimated 71.6 million boomers in the U.S in 2019, making them the largest living adult generation at the time. When so many people retire at the same time, there is bound to be an extra burden on the federal government’s resources, causing a spike in taxes. So, planning your retirement tax strategy becomes particularly vital at this time.
Here are some things you can follow to ensure efficient tax retirement planning:
You can consider converting to a Roth account before you retire. If the tax liabilities amount to a lot, you can balance it out by working or investing more. You could take up a part-time job or work a few extra shifts. You can also consider investing in high yield stocks to make up for the amount paid in taxes. This way, your retirement savings will not be affected, and you can expect to enjoy a tax-free income from your IRA in your golden years. A Roth IRA is also a better option if you wish to include it in your estate and pass it on to your heirs. Typically, beneficiaries have to withdraw all the money from the inherited retirement account within 10 years of inheritance. This increases their taxable income. However, with a Roth IRA, they will be able to enjoy tax-free withdrawals that can benefit them more.
Considering the fact that the taxes are considerably low in 2021, this can be an excellent time for a retirement tax planning strategy like Roth conversion. Moreover, since most people have suffered income cuts due to the pandemic, your taxable income is likely to be low anyhow. Even after adding the additional taxes from the Roth conversion, you will remain in a lower tax bracket as compared to any other year.
When you decide to retire, you should look at all the taxes charged in the state you reside in. Some people may want to move to a new state or country after retirement. In case you choose to do the same, find out the taxes charged in your new place of residence. You should also look at taxes, such as sales tax, property tax, etc., along with the cost of living, as these can add up to a lot and ultimately lower the value of your retirement income. Also, keep in mind that as important as it is to consider factors like safety, weather, healthcare, proximity to loved ones, etc., while deciding on a place to retire and settle in, it is equally necessary to understand the taxability laws of the region.
You can also invest in publicly traded U.S corporations. The dividends received from these are taxed at a lower rate than ordinary income. In addition to this, you can try some other retirement tax strategies like using losses from the sale of a property or other securities to offset capital gains.
Apart from the above, another effective strategy to follow here is to avoid two distributions in a year. Your first RMD is due by April 1 of the year after you turn 72 or 70.5. Your second and all subsequent distributions are due by December 31 each year after that. If you delay your first distribution until April, you will be forced to take two distributions in the same financial year. This will result in a high taxable income and put you in a high tax bracket for the concerned year. So, plan your distributions in a manner that they fall in two different financial years for tax commuting purposes.
Lastly, if you have enough income sources other than retirement accounts, you can consider donating your IRA funds to a charity. After the age of 70.5, you can save tax on up to $100,000 (individually) and $200,000 (as a married couple) per year on IRA withdrawals donated to charity. If you do not intend on using your IRA income, charity can help you avoid taxes too.
You can maximize your contributions as per the annual limits and lower your taxable income. Your investments will grow tax-free. The qualified withdrawals in retirement after the age of 65 will also be tax-free. Although non-qualified withdrawals used for expenses other than medical are taxed as ordinary income, HSAs are exempt from RMDs. So, you can still end up saving a lot of tax.
The right tax planning strategies for retirees can change the course of your retirement. Keep in mind that retirement planning is not limited to how much money you can save up. It is also about how you liquidate your savings to earn maximized benefits without incurring heavy taxes. Simple measures like buying a life insurance plan, making last minute Roth conversions, selecting a good place to settle, etc., can help. These steps do not require any professional guidance and can be easily undertaken after some careful planning and evaluation from your end. For other major decisions like picking tax-efficient investments, prioritizing and planning your distributions, moving funds to a QLAC, etc. you may require some professional guidance. In this case, you can get in touch with a professional financial advisor in your area and make better retirement tax planning decisions to ensure that you live a comfortable and financially stable retirement life.
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The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.
A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.