7 Ways Retirees Can Reduce Their Income Taxes

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Retirement is the time to enjoy the fruits of many years of hard work.

However, if you’re not careful, Uncle Sam can dip into your hard-earned savings and claw it back little by little, year after year.

When the taxman comes during your working years, it’s annoying. But it’s even worse during your golden years, when you no longer have a full-time income and every penny counts.

Fortunately, you can take steps to keep the government at bay. Here are several ways to reduce your tax bill during retirement.

1. Convert to a Roth IRA – with care

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Once you hit age 72, old Uncle Sam will come knocking on the door and demand that you start making annual withdrawals from traditional retirement accounts, including 401(k) plans and accounts. individual pensions.

And when you make those mandatory withdrawals — known as required minimum distributions, or RMDs — you’ll have to pay taxes on them.

One way to minimize the tax bite is to plan ahead.

Long before you hit 70, slowly convert portions of your traditional retirement funds into a Roth IRA, which is not subject to RMDs. This strategy is particularly good in certain situations, such as if you are retiring early and expect your income to be lower for several years.

For example, if you plan to live off a mountain of savings you’ve accumulated in a bank account — and you’ll have few regular sources of income during that time — you could find yourself in a lower tax bracket. Move money from tax-deferred accounts into a Roth IRA during such a period, and you’ll only have to pay taxes at that low rate. The money will then grow tax-free and future gains will be tax-free when withdrawn.

Admittedly, this strategy will not be feasible for everyone. But it can be a good strategy for some.

Before considering it, however, be sure to speak with a qualified tax professional or financial adviser. If you’re not sure where to start or already know you want a fiduciary – an advisor who’s bound to act in your best interest – consider checking out Wealthrampa free service that connects you with licensed fiduciary advisors in your area.

2. Donate to charity

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Yes, the changes brought about by the 2017 federal tax code overhaul have made it less attractive to contribute to charity, at least in terms of tax relief.

However, a big tax break remains for retirees who want to donate to the charity of their choice. You can use the money you need to withdraw for any required IRA or 401(k) minimum distribution and donate it to a good cause.

As we detail in “5 Ways to Avoid Social Security Income Taxes”:

“If you are at least 70 ½ years old, you can take up to $100,000 of your required annual minimum distribution, give it to charity and avoid tax on the money. This is called a qualified charitable distribution.

3. Take advantage of favorable capital gains rates

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When your income is low, so is your capital gains tax rate. In fact, it’s positively underground.

You will be do not pay capital gains tax on investment gains held for more than a year if your income falls below certain levels. If your income is a little higher, you can pay a rate of 15% or 20% in most cases.

So it may be a good idea to sell stocks and other long-term investments when your income is lower. However, it is also foolish to sell stocks just to get tax relief. Weigh other factors before making this move – and consider consult a financial professional for advice.

4. Delay applying for Social Security

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It hardly seems fair: after years of paying extra taxes that contribute to your fellow citizens’ social security benefits, you may be taxed on yours Social security benefits upon retirement. This is what happens if you earn too much of what the Social Security Administration calls your “combined income.”

There are several ways to avoid this fate, but perhaps the easiest is to simply delay applying for your Social Security benefits. In fact, if you’re waiting until you’re 70, you can also significantly increase the amount of your monthly Social Security payment since benefits increase each year you delay until that age.

However, before deploying this strategy, be aware that it does not always make sense. Money Talks News founder Stacy Johnson details the pros and cons in “Should We Take Social Security at 62, 66, or 70?”

5. Keep the right mix of investments

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One of the most overlooked ways to save on taxes in retirement — or at any other age — is to make sure you keep the right mix of investments in your taxable and non-taxable accounts.

With this strategy, you keep tax-efficient investments, such as stocks, many types of mutual funds and ETFs, and municipal bonds, in your taxable accounts. Less tax-efficient investments — many types of bonds, CDs, real estate investment trusts — should be held in tax-deferred and tax-free accounts.

Those who fully understand this concept can create the right mix themselves. For many of us, it’s best to turn to professional help. Stop by the Solution Center and find a great financial advisor.

6. Withdraw money wisely

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Eventually, you’ll probably have to withdraw the money you’ve saved for retirement. Doing it the right way can give your bottom line a boost.

In 2020, Morningstar researchers crunched the numbers and discovered that simply withdrawing funds from your accounts in the most tax-efficient way can increase your retirement income by 4%.

This means that if you withdraw $50,000 each year, you can increase your take by an additional $2,000.

Again, executing this strategy correctly is not always easy. As a general rule, many experts suggest withdrawing from taxable accounts, tax-deferred accounts, and tax-free accounts in that order. However, your personal situation will determine if this is the right approach.

So seeking help from a financial advisor is probably a smart move if you are in this situation.

7. Stay frugal

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Another sensible way to reduce your tax bill is to simply reduce your expenses. It is true that once you reach age 72, you will be required to make the required minimum distributions from traditional retirement accounts. But you are only required by law to withdraw this minimum and not a penny more.

However, if you overspend in retirement, you may be forced to dip deeper into these accounts. This could drive up your tax bill.

So if you’ve spent years being smart with your money, don’t get silly now that the ballgame has entered the final innings. Keep it frugal and you’ll reap the tax benefits.

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