Retirees Could Cut Their Tax Bills by Thousands With This One Move
Written by
Gabriel Vito
Edited by
Zuri Anderson
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You might think retirement means a smaller tax bill since you are no longer working. For many retirees, it does not always work out that way.
A big reason is required minimum distributions, or RMDs. Starting at age 73, most retirees must withdraw money from tax-deferred accounts like traditional IRAs and 401(k) plans. Those withdrawals are taxed as ordinary income and can push retirees into higher tax brackets, which can increase how much of their Social Security is taxed and raise Medicare premiums.
The “one move” is reducing how much of your RMD is counted as taxable income. The right approach depends on where you are in retirement.
Before Age 73, Roth Conversions Can Lower Future Taxes
Before RMDs begin, a Roth conversion can give you more control over how your retirement income is taxed.
A Roth conversion moves money from a traditional IRA into a Roth IRA. You will pay taxes on the amount you convert now, but future withdrawals from the Roth are tax-free, and the account is not subject to RMDs for the original owner.
In those early retirement years, many people are in a lower tax bracket. Converting portions of a traditional IRA during that time can shrink the balance that will later be subject to required withdrawals.
“The single most effective move retirees can make to reduce the tax burden on required minimum distributions is to start doing Roth conversions before RMDs kick in,” said Steve Sexton, CEO of Sexton Advisory Group.
After Age 73, QCDs Can Cut Your Tax Bill
Once RMDs begin, one way to lower your tax bill is through a qualified charitable distribution, or QCD.
A QCD lets you send money directly from your IRA to a qualified charity. That amount still counts toward your required withdrawal, but it does not get added to your taxable income. This matters beyond just the income tax. Keeping that income off your return can also affect how much of your Social Security is taxed and whether your Medicare premiums go up.
This works best for retirees who do not need their full RMD to cover living expenses and are already inclined to give to charity.
“The QCD counts towards your RMD but is not taxed as income,” said Morris Armstrong, an enrolled agent and founder of Morris Armstrong EA LLC.
For example, if you are required to withdraw $40,000 but only need $30,000 to live on, you could send that extra $10,000 directly to a charity through a QCD. That money was leaving your account either way. The difference is whether it goes to a cause you care about or to the IRS as taxes.
Note that QCDs can only be made from IRAs, not 401(k) accounts.
Final Take To GO
Lowering taxes in retirement is not about finding one more deduction. Roth conversions shrink the balance that generates future RMDs. QCDs keep that income off your return once they start. Both lead to a smaller number on line 15 of your 1040.
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