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Taxes in retirement: 7 ways to trim your bill

Posted at 12:57 PM, Apr 03, 2019

Whether your retirement is decades away or just around the corner — or you’re already living the dream — there are a few simple things you can do now to lower your taxes.

Taxes? In retirement? Yes and yes. A chunk of your Social Security benefits likely will be taxed. The money you take out of your traditional IRA and 401(k) will be taxed. And investments you have in a regular brokerage account may face taxes on capital gains and dividends.

The following ideas could save you big time — making your retirement years a little less stressful.

1. Get money into a Roth IRA

Hands down, the easiest way to trim your tax bill in retirement is to put money into a Roth IRA today . Rules apply, but follow them and everything you put into the Roth — your contributions as well as the money you earn in that account — comes out tax-free in retirement.

“That’s one really good way” to lower your retirement tax bill, says Alan J. Straus, a certified public accountant and attorney in New York City.

There are a few ways to open a Roth:

  • You can contribute to a Roth 401(k) if your employer offers one.

There is a downside (hey, nothing’s perfect): With a Roth IRA, the tax break comes later. You put money into the account after paying taxes on it. That’s unlike a traditional IRA or 401(k), both of which give you an upfront tax break. Maybe think of the Roth as current pain for long-term gain.

2. Open an HSA

This one’s only for people who have a high-deductible health insurance plan. As long as the health plan you have meets the IRS’s guidelines (among other rules, the deductible must be at least $1,350 for an individual plan and $2,700 for a family plan), you’re allowed to open a health savings account, which is one of the sweetest savings deals around.

You get to put money in pre-tax, that money then grows tax-deferred and, as long as you spend the money on qualified health costs, you never pay taxes on it. The annual HSA contribution limit is $7,000 for a family plan and $3,500 for an individual in 2019.

3. Pay off your mortgage and reduce expenses

The less you need to withdraw from retirement accounts that require taxes on withdrawals, such as traditional IRAs and 401(k)s, the lower your tax bill.

Given that a mortgage tends to be one of the biggest bills you could make withdrawals for, it makes sense to try to get it out of the way. By the time you retire, it’s also likely you’ll be paying mostly principal, not interest, and thus not getting much tax benefit from the mortgage interest deduction.

Another idea? Consider moving to a cheaper state. You’re probably not going to move somewhere for taxes alone, but if you’re thinking of moving anyway, keep taxes mind. It could save you some big bucks. Some states don’t have an income tax; some don’t tax retirement income.

4. Time your investment sales

If you have stocks with big price gains and you want to sell, maybe hold off selling those stocks until a year when your overall income — and thus your tax rate — is lower.

“In lower tax years, that might be a good year to harvest a capital gain for something you’re thinking about selling,” says Mark Luscombe, principal analyst with Wolters Kluwer Tax & Accounting in Riverwoods, Illinois. “The inverse of that is to realize investment losses in what otherwise might be a higher income year.”

Your losses first offset any capital gains, but net capital losses can offset up to $3,000 of ordinary income each year.

5. Consider investing in municipal bonds

Generally, municipal bonds are tax-exempt, meaning you won’t owe federal tax (and may not owe state tax) on the income you receive. If they fit into your overall investment plans, that extra tax-free income could be a good thing.

“You suffer a little lower interest rate, but you can control when you withdraw that money and when you withdraw it, it is tax-free,” Luscombe says.

(There are some downsides, though. For example, you’ll have to include your muni bond income for the purposes of taxing Social Security.)

6. Manage retirement withdrawals

If you’ve got a traditional IRA or 401(k) and a Roth IRA or Roth 401(k), then one way to control your taxes is to manage your withdrawals in retirement.

In years when, for whatever reason, you’re in a low tax bracket, consider withdrawing taxable money for your living expenses. In years when you’re in a higher tax bracket, then it’s smart to withdraw from your Roth IRA so your income isn’t taxed at high rates.

Similarly, you can use low-tax years to convert your traditional IRA to a Roth. When you pull money out of an IRA it becomes taxable, even when you’re converting that money to a Roth . So it makes sense to do that in years when your income is low — and to convert just enough so that your income that year doesn’t get pushed into a higher tax bracket. That way, you’re paying a lower tax rate and getting all that money into an account where the money comes out tax-free.

“If you’re having a terrible year income-wise and you have this traditional IRA money or traditional 401(k) money, then the years where you have low income you’ll also be in a low tax bracket, so you could manage the amount of tax you’re paying to move the money from regular to Roth,” says Steven B. Zelin, a CPA and managing member of Zelin & Associates CPA LLC in New York.

7. Donate from your IRA

If you’ve reached the age where you have to start pulling money out of your traditional IRA, aka age 70½, consider donating to your favorite charities directly from your traditional IRA.

That tax perk lets you avoid income tax on up to $100,000 per year. You can use all or a portion of that donation to count for your required minimum distribution from your IRA.  (But, if you do contribute from your IRA, you can’t also claim a deductible charitable contribution for the same amount.)

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