Worrying about taxes doesn’t end once you’re in retirement. Navigating tax time can be just as difficult in your retirement years as it was when you were working. If you’re looking for proven ways to reduce your tax liability in retirement, these seven tips are a good place to start.
1. Make Withdrawals Strategically
In retirement, you often have income coming from many different savings accounts. Some of those accounts will be tax-deferred accounts, and it may be in your best interest to delay withdrawals from those accounts as long as possible limiting your taxable income each year. So, if you have a taxable account and a tax-deferred account such as a 401K, you’ll want to defer making withdrawals from the 401k for as long as possible to keep you from moving into a higher tax bracket and having a higher tax bill.
2. Max Out Your Tax Bracket
If at the end of the year you find you haven’t maxed out your current tax bracket consider withdrawing income from tax-deferred accounts to reduce your future taxable income. For example, if you have a large IRA and still have some wiggle room before you max out your current tax bracket, consider withdrawing funds from that IRA in the current year. Yes, you will be taxed on the money you withdraw, but only at your current tax rate. Each year you can reduce the amount of your IRA, the less money you have to pay in taxes in the future.
3. Reduce Expenses
Sometimes paying less in taxes in retirement simply means reducing your current expenses. The less money you have to put out each month is less money you have to withdraw from your retirement accounts. Talk with your financial planner and see the type of tax hit you would take if you paid off major expenses such as your car note, a mortgage – if you still have one – and other bills that aren’t part of monthly living expenses. You may find taking one big tax hit to eliminate those bills, means a much lower tax liability in the future as you will need far less money to live on month-to-month.
4. Combine Income and Deductions
Try pulling some deductions into the current tax year to help minimize your overall tax liability. An example would be paying as many real estate taxes as you can in the current year, such as paying a January tax bill in December, allowing you to itemize your taxes. With those extra deductions, you can increase your income for the year without increasing your tax bracket and paying a higher tax rate.
5. Minimize Taxes on Social Security Benefits
Your Social Security benefits are taxed based on your combined income. If you file jointly and your income is below $32,000, you won’t have to pay taxes on your Social Security benefits. If you’re single and your combined income is below $25,000, you won’t have to pay taxes on your Social Security benefits, either. As your taxable income increases, however, the more taxes you will have to pay on your Social Security benefits.
6. Consider Moving to a Roth IRA
While this isn’t a strategy that will work for everyone, if you have a large IRA consider moving some of it to a Roth IRA to help reduce future tax liability. The move can also help minimize your future minimum IRA distributions. To see if this strategy will work for you, mock up a tax return in the fourth quarter and see how much money you can remove before pushing yourself into a higher tax bracket.
Jeremy Wallace is founder and chief investment officer at Wallace Hart Capital Management, an independent financial services firm committed to offering comprehensive advice and customized services. Jeremy has 20 years of experience in the financial industry and is passionate about helping clients preserve and enhance their wealth so they can pursue their passions. Jeremy graduated from Emory University with a degree in international economics and a certificate in financial planning. Outside of the office, Jeremy spends most of his free time with his wife, Julie, and their three children, Isabel, Lincoln, and Reid. He is an avid Chicago Cubs baseball fan, and he enjoys golfing with his wife and traveling with his family. Learn more about Jeremy by connecting with him on LinkedIn.