In your younger days, saving for retirement meant socking away whatever you could afford. Hopefully, as you grew in your career, it became easier to set aside money for your golden years.
Now that you’re in your 60s, it’s time for your plan to shift once again. “As you approach retirement, focus turns on making your money last,” said Tyler End, CEO and co-founder of Retirable. “One of the best ways to make that happen is minimizing the amount of taxes you pay.”
One big driver of taxes in retirement results from distributions out of your retirement investment accounts, including 401(k) plans and IRAs. With traditional accounts, you put money in pretax, and when you withdraw funds, you pay income taxes on the distribution.
“The first step is to avoid penalties on these distributions,” End said. For example, avoid taking money out before you reach age 59 ½, otherwise you’ll face a 10% penalty on top of regular income taxes (with some exceptions). Additionally, make sure to fulfill your required minimum distributions (RMDs) when you hit age 72, or else pay a tax penalty of 50%.
Perform a Roth Conversion
Another way to shelter your retirement savings from high taxes is to convert your account to a Roth IRA.
“One of the smartest money moves I have ever seen was with a client of mine who converted his big taxable 401(k) into a Roth IRA a few years before we met, while he was in his early 60s,” said Matthew Grishman, principal and wealth advisor at Gebhardt Group, Inc. “Now in his late 70s, after enjoying the nearly 14-year uninterrupted bull market that ended in January of 2022, this client is enjoying tax-free withdrawals from a much larger Roth IRA.”
This strategy is known as a backdoor Roth IRA. It allows you to side-step IRS income limits and put money into a Roth IRA. Contributions are taxed upfront and withdrawals are then made tax-free. It’s a particularly good strategy for high-income taxpayers who have high-growth investments that they want to shield from a large tax bill in retirement.
Grishman noted that this strategy works best if you have the cash in a non-retirement account to pay your tax bill when the conversion takes place. “By converting your current 401(k) or IRA to a Roth, you eliminate two financial pain points: income taxes on withdrawals in the future, and no longer are you required by law to take required minimum distributions,” he added.
Relocate To a Low-Tax State
State taxes can play an important role in a retiree’s financial plan, said Herman Thompson, Jr., a certified financial planner with Innovative Financial Group in Atlanta. In fact, nine states currently do not levy a state income tax, many of which have become popular destinations for retirees.
“State taxes can be the difference in moving to Santa Rosa Beach instead of Kitty Hawk,” Thompson said. If you’re looking to reduce taxes in retirement, consider relocating to an area where you don’t have to pay state income taxes.
Claim a Property Tax Discount
If you own real estate, you might qualify for a reduction on property taxes, according to Jean Smart, CEO and founder of Penelope, a retirement savings platform for small businesses and entrepreneurs. She noted that seniors over the age of 65 who live in certain states (or 61 for Washington residents) are eligible for the discount.
“The key is to check state websites for rates and deadlines since the state, county or city agency that collects your property taxes usually won’t notify you that you qualify for an exemption,” Smart said. Instead, you’ll need to find out if you qualify and claim the deduction on your own. To do that, check with your official state government website for information related to taxes, revenue or finance. Here, you should be able to see local rules for senior property tax exemptions.
Keep the Big Picture in Mind
Finally, End noted that as with any strategy in retirement, it’s important to look at the impact of tax planning on a holistic level and not focus so much on taxes that you lose sight of the big picture. “Too often, we see people prioritize lower income at the expense of sound financial decision making,” he said.
If you aren’t sure about the best ways to reduce taxes while meeting your financial goals, consider working with a tax professional or financial planner who can help you build out a well-rounded and strategic plan.
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