It can be easy to underestimate the role of taxes in retirement. Because taxes are frequently associated with income during the working years of life, many overlook tax planning during this next chapter. However, if properly managed, there are serious financial advantages to be gained by an effective retirement tax strategy. Here are 5 strategies that will help you avoid leaving the IRS a tip so you can keep more of your hard-earned money in your pocket.
1. Create a Withdrawal Strategy
When it comes to withdrawing from your retirement accounts, how you take your distributions can make all the difference. Your retirement income sources are likely produced from a variety of assets, including employer-sponsored retirement plans, Social Security, personal IRAs, or other income-generating investments. Each asset has different tax characteristics, and properly structured investments can help lower your tax burden if you plan how and when you’ll withdraw from each.
For example, most people will receive Social Security benefits during retirement, but 85% of your Social Security income can be taxed at your regular tax rate if your income exceeds a certain amount. (1) A financial professional can help you determine how Social Security will fit into your overall plan and structure your other investments to alleviate the tax burden on Social Security income.
Regarding your personal savings, a $50,000 withdrawal from a Roth IRA will have a wildly different tax impact than that same distribution from a traditional IRA. If you blindly take your money and run, you could trigger an avalanche of higher Social Security taxes, investment surtax, capital gains taxes, and even higher Medicare premiums, which will eat away at the funds that were supposed to carry you through retirement. Creating a tax plan can help you avoid these financial pitfalls.
2. Contribute to a Health Savings Account
Health savings accounts (HSAs) offer a triple-tax savings. It may sound too good to be true, but HSAs have no federal income tax, no state or local taxes, and no Federal Insurance Contribution Act (FICA) taxes. If you are eligible for an HSA, your money will be tax-deferred and can be withdrawn tax-free to pay for medical expenses.
Because HSA account balances simply roll over from year to year, by contributing to the limit each year, you can build up quite a nest egg to cover either current medical expenses or future medical expenses in retirement. Think of it as a Roth IRA for medical expenses. In 2021, HSA owners now have higher contribution limits to help them do just that. If you have individual coverage, you can contribute $3,600, and for family coverage, your limit is $7,200, with an extra catch-up contribution of $1,000 available for those over age 55. If you can’t max out the yearly limit, attempt to contribute enough to cover your deductible and take advantage of your employer match, if available
3. Utilize Roth IRA Conversions
If you primarily have a traditional 401(k) or IRA, a conversion to Roth may save you tens of thousands of dollars in taxes over the course of retirement. A Roth conversion allows you to take your traditional pre-tax 401(k) and turn it into a post-tax account. When you take withdrawals from a traditional 401(k), you pay regular income tax for that money in the year you take it out. However, withdrawals of the growth from a Roth account are tax-free, meaning that all of the interest your money earns during the rest of your retirement has no tax burden when you take it out.
Conversions can be tricky, and since you have to pay the taxes on them at the time you convert, it usually makes sense to do this over the course of several years. You can take advantage of low-income years, such as when you have stopped working but are not yet collecting Social Security, to convert your funds to a Roth IRA so that you will have tax-free income later. It is important to be mindful of tax brackets when you do conversions so that you don’t inadvertently push yourself into higher tax rates.
4. Consider Tax-Loss Harvesting
Tax-loss harvesting is a strategy that allows you to offset your capital gains by capital losses. If you own a losing bond, mutual fund, or stock in accounts other than your 401(k) or IRA, review your realized and unrealized gains and losses. You might be able to offset some of your gains by selling some losses and thus lower your taxable income. And if you live in a high-tax state, you may want to defer tax by deducting up to $3,000 of capital losses in excess of capital gains and carrying any leftover capital losses forward into future years. (2)
If you have done very well and find yourself paying a large amount in taxes every year during retirement, tax-loss harvesting can help offset the tax pain. This can also be a helpful tool if you are facing a large one-off tax bill, perhaps in the same year as a Roth conversion or after a heavy liquidation from a traditional 401(k) or IRA.
5. Donate Effectively
If you are charitably inclined, one of the best ways to save on taxes is through donations. You can get a tax deduction on donations up to 60% of your adjusted gross income. (3) If you have appreciated assets, you can get an even greater tax break. When you donate an appreciated asset that you have owned for over a year, such as stocks, to a charity, you do not have to pay capital gains taxes on the appreciation, but you still get to claim the full value for your deduction. This allows you to avoid the capital gains tax altogether. If your assets have declined in value, it is best to sell them yourself and donate the proceeds so that you can claim the loss when filing your taxes.
You may also want to look into using a donor-advised fund to combine all charitable contributions in a year and then distribute the funds to various charities over several years. With this strategy, you may be able to itemize deductions in one year and take the standard deduction in the following years so you can achieve a tax benefit that you may not have received otherwise.
Partner With a Professional
Whether you are looking at withdrawal strategies, Roth conversions, or something more complicated like tax-loss harvesting, you don’t want to try to figure it out on your own. That’s why it’s wise to partner with a financial advisor.
T.A. Holland & Co. has professionals ready to help you navigate the financial ebbs and flows of retirement, and keep you confident in the strength and security of your portfolio. To get a personalized tax analysis of your retirement plan, contact our office today by calling 617-523-5656 or emailing info@taholland.com to schedule a complimentary appointment.
About T.A. Holland & Co.
T.A. Holland & Co. was founded in Boston, Massachusetts, in 1920, and serves individuals and businesses throughout the country. We provide cutting-edge financial services with a broad array of solutions to help our clients grow and preserve their wealth. We have seen good and bad economic times. Through it all, T.A. Holland & Co. has thrived by always making the customer our #1 priority. We get to know you and understand your needs so we can provide you with the proper guidance and strategies. Our senior vice president, John Hellmuth, has been at the helm of T.A. Holland’s financial services since 1990, but he doesn’t do this job alone. He is joined by his two children, Lindsay Hellmuth and Thomas Hellmuth. As CERTIFIED FINANCIAL PLANNER® (CFP®) practitioners, our financial services team has the knowledge and experience to help you solve your most pressing financial challenges. To learn more about how we can help you, visit our website and reach out to us at (617) 523-5656 to schedule a complimentary get-acquainted meeting.
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(1) https://www.ssa.gov/benefits/retirement/planner/taxes.html
(2) https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting