5 Best Tax Planning Strategies for Retirees To Do Now
Written by
Marc Guberti
Edited by
Amen Oyiboke
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Good tax planning can help you save money and maximize every dollar you have. When you retire, it’s about preserving your nest egg and getting the most out of Social Security and other income sources.
These are some of the strategies you may want to consider to reduce your tax bill as a retiree.
Delay Your Withdrawals
If you contributed to a traditional retirement account, there isn’t an incentive to rush your withdrawals. That’s because withdrawals from a traditional retirement account count as ordinary income, which is a taxable event.
You can review your other income sources, such as your Social Security or a part-time job, to determine the optimal amount to withdraw. You should avoid making a high enough withdrawal that moves you into a higher tax bracket.
You will eventually have to take out the required minimum distributions when you turn 75 (assuming you were born in 1960 or later). If you leave a traditional retirement plan with an heir, that person is required to withdraw all funds within the next 10 years. Furthermore, all withdrawals show up as taxable income for the heir. Typically, it is better to withdraw from your retirement account since you will likely have a lower income at that point than your heir by the time they receive your retirement account.
Contribute to an IRA
You can contribute to an IRA at any age, even when you are retired. Contributing to a traditional IRA minimizes your tax burden, while a Roth IRA shields your portfolio from capital gains taxes and dividends.
Roth IRAs are great for transferring wealth since your heir won’t have to pay taxes on any capital gains or dividends. The heir can also keep funds in your Roth IRA for up to 10 years, allowing additional years of tax-free growth. Furthermore, Roth IRA withdrawals are not taxed.
While Roth IRA contributions in your retirement years are great for a multi-generational wealth-building strategy, traditional IRAs provide some relief if you earn more Social Security income than you spend. You can use traditional IRA contributions to lower your tax burden.
Use Tax Loss Harvesting
If you have any stocks that have lost you money, you may want to sell them at the end of the year. Even if you are bullish on those stocks, it can be worth selling the security, buying a similar one, and then re-entering your preferred stock after 30 days.
The 30-day window is important because it allows you to avoid the wash sale rule, a pesky rule that negates your capital loss for tax purposes if you repurchase shares too early. You can use the net losses to reduce your tax bill while entering a similar position. For instance, an investor can sell SPY stock at a loss and use those funds to buy VOO stock instead. Both exchange-traded funds (ETFs) generate nearly identical returns since they mirror the S&P 500.
Move to a Tax-Friendly State
Some states are more friendly than others when it comes to taxation. Some states have zero income taxes, but you also have to watch out for other taxes. For instance, Texas has no state income taxes but has very high property taxes to compensate for it. Downsizing in an area with lower taxes will also give your nest egg more room to stretch.
Map Out Social Security Taxes
Only eight states tax Social Security benefits, but even if you live in one of the 42 states that don’t tax your benefits, you still have to pay federal taxes on your Social Security payouts. Social Security is treated as ordinary income, but it’s only taxed if your Social Security benefits and other income sources reach a specified level.
The IRS periodically adjusts this level. Single filers and married filers with taxable incomes below $25,000 and $34,000, respectively, don’t have to pay taxes on their Social Security benefits.
Depending on how much they make from Social Security and other sources, retirees may have to pay taxes on up to 85% of their Social Security benefits. That doesn’t mean you’re getting an 85% tax rate on your Social Security, but it will be taxed at a percentage based on your ordinary income.
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