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Minimizing Taxes In Retirement: Top 4 Tips

Posted by Jim Kantowski, CFP®, CPA on October 15, 2020

Minimizing Taxes In Retirement: Top 4 Tips

Retirement should be a time of enjoyment, but it can be stressful if you’re not sure whether you’ll have enough money to cover your expenses and leave room for leisure activities. Avoiding taxes in retirement is one way to keep more of your wealth in your bank account to fund the lifestyle you desire.

Tax planning can be complicated, but the good news is you don’t have to tackle it alone. In this article, we’ll share our top four retirement planning tax strategies that you can get started on today, while you’re still in your working years.

Do you know which accounts you should make withdrawals from in retirement to reduce your tax bill? Bay Point Wealth’s team of seasoned Certified Public Accountants and Certified Financial Planners can help. Schedule a call today.

Avoiding Taxes In Retirement: 4 Tips

1. Have multiple retirement accounts.

Contributing to various tax-efficient accounts while you’re still in the workforce will help you minimize your tax bill during retirement by giving you the flexibility to pull money from different accounts during your golden years.

Ideally, you should hold pre-tax investment tools such as Individual Retirement Accounts (IRAs) and company retirement accounts or 401(k)s. These accounts give you a tax break on the money you initially deposit, but you’ll be taxed on the money you take out (as ordinary income) when you make withdrawals, which you can start doing as early as age 59 ½.

You should also hold post-tax investments such as Roth IRAs, which are taxed upfront but enable you to withdraw money tax-free. Roth IRAs are especially useful if you are in a low tax bracket now and expect to be in a higher bracket when you need the funds.

Finally, having a pot of money in after-tax non-retirement accounts such as savings accounts gives you an added layer of flexibility in case you retire early. Remember that with all of the accounts discussed above, you should try to fund the one that gives you the biggest tax break first.

2. Make tax-efficient withdrawals.

When you begin to pull money out of your accounts in retirement, your withdrawals should be based on the type of account and your income tax rate in that year to ensure you will be taxed as little as possible.

Having a strategy to use each investment in a tax-efficient way is extremely important. You may want to use money from your IRA in lean tax years before you begin taking Social Security to leverage the low tax rate. You can also convert IRA assets to Roth IRAs and use after-tax non retirement money to fund your expenses. This will allow you to withdraw money at a lower tax rate, and enable your wealth to grow tax-free in the future.

For example, if you retire at age 62 with an IRA, a Roth IRA, and Social Security benefits, you could wait to begin taking Social Security and allow your benefit to continue to grow at 8% per year until you turn 70. The longer you hold off before withdrawing your money, the greater the benefit you’ll receive. At the same time, you could use your IRA to fund your expenses, pulling your money out at a low tax rate.

3. Take advantage of tax-loss and gain harvesting.

Tax-loss harvesting occurs when you sell an investment at a loss, recognize the loss, and use it to offset gains. For example, if you bought Amazon stock for $10,000, then the stock market tanks and it’s worth $7,000, you can sell the stock at the lower price and use the loss of $3,000 to offset taxes on your other income sources. This is a solid strategy for avoiding taxes in retirement by offsetting capital gains and ordinary income by up to $3,000 per year.

Tax-loss harvesting can also be part of your estate planning strategy, which involves the distribution of your assets when you pass away. This is important to consider in retirement, especially if you wish to pass wealth down to future generations.

For example, when you recognize a loss and use it to offset a gain, you may choose to repurchase that investment, and it may increase in value. If that happens, you’ll have an unrealized gain. If you pass away with that gain in your portfolio, you can transfer the investment to future generations without having to pay capital gains tax on it.

On the flip side, if you run into a year where your income is low, you can sell some stocks and potentially pay 0% tax. The current tax law in 2020 offers a 0% rate on capital gains, as long your taxable income is below $40,000 for a single payer and $80,000 for a married couple.

Do not waste an opportunity to reduce taxes. You never know when the laws will change.

4. Make charitable gifts.

Charitable gifting is one of the best retirement planning tax strategies because there are so many options, and it enables you to reduce your taxable income by including gifts as itemized deductions on your tax return, or using them to avoid including your required minimum distribution as income. In addition, charitable gifting may allow you to avoid paying capital gains on a highly appreciated investment.

For example, if you bought Google stock for $1,000 and it turned into $100,000 (congratulations, by the way!), you could transfer that gain to a charity in the form of a gift, which means you won’t have to pay tax on it, nor will the charity.

Another option for avoiding taxes in retirement through charitable gifting involves putting your money in a donor-advised fund. Take the same Google stock example—if you put your gain in a donor-advised fund, you don’t have to choose a specific charity to give to right away, and you’ll still get a tax deduction. You’ll also have the flexibility to donate the money over time to different charities. This is an excellent way to minimize tax during a high-income year, for example, if you own a business and sell it for a substantial profit.

Get Tax Advice From Bay Point Wealth

The tax world isn’t everyone’s cup of tea, and the laws change constantly, which means it can be difficult to stay up to date. At Bay Point Wealth, we believe taxes are an essential part of your overall financial picture. We take a proactive approach to tax planning, so we’re always looking for tax savings opportunities for our clients. If you’re ready to see how much money you can save at tax time, we’d love to hear from you.

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