Retirees rely on a variety of income sources to sustain their lifestyle. These sources may include distributions from individual retirement accounts (IRAs) or other retirement plans, Social Security benefits or funds from personal savings or investments. However, even with ample income sources, many people worry about how taxes will affect their money after retirement. Minimizing this tax burden is a primary goal for many people as they approach retirement. Fortunately, retirees can implement many different tax strategies for retirement to help lower their tax bill and enjoy their golden years without fear of financial troubles.
Review Investment Portfolios
Many financial professionals recommend that people review their investment portfolio as they near retirement age. Making a move towards more conservative investments later in life can help preserve the principal and help save taxes for retirement. Profits from investments such as capital gains, dividends, accrued interests and mutual fund earnings tend to attract similar taxes after retirement as they did prior. Therefore, it is a wise option to restructure the portfolio to minimize the tax burden from investments.
Calculate Social Security Taxes
Gain a better understanding of how Social Security is taxed and what a person can expect to pay in Social Security taxes during retirement. Whether or not Social Security is taxable is based on the person’s provisional income. Social Security is not taxable if a person’s provisional income is less than $25,000 for singles or $32,000 for married filing jointly.
Certain income sources do not count in this calculation, including income from some annuities, municipal bond income, and Roth IRAs income. Individuals who have provisional income levels above these maximums may be subject to taxes on 50 percent or more of their benefits.
There are certain options that retirees can take to avoid taxes on Social Security benefits. Individuals who are age 70½ or older can choose to donate up to $100,000 annually to charities tax-free from their traditional IRAs. This qualified charitable distribution keeps the required minimum distribution (RMD) out of the provisional income calculation and can help a person stay below the cutoff amount that determines Social Security tax.
Move to a Tax-Friendly State
Although this is not an option for everyone, some people can greatly benefit financially from moving to a more tax-friendly state. There are currently seven states in the U.S. with no income taxes, including Florida, Alaska, Texas, South Dakota, Nevada, Wyoming, and Washington. In Tennessee and New Hampshire, there is tax-only interest and dividends. However, starting with the 2021 tax year, Tennessee will repeal this tax.
It is also important to be familiar with retirement tax rules in the U.S. For example, federal law states that no U.S. state can tax a resident’s retirement benefits that he or she earned in a different state. Some states also provide residents with low-income taxes or special breaks on their retirement income, helping individuals save even more of their retirement income.
Leverage Roth IRAs
Roth IRAs can be highly advantageous for retirees who want to avoid a massive tax burden. A Roth IRA refers to a type of retirement account that is funded with after-tax contributions. Roth IRAs can be set up by nearly any financial institution and can include a wide range of investment options. With a Roth account, retirees can withdraw income free of taxes.
There are some restrictions to consider when comparing retirement accounts. Anyone that has earned income can contribute to a traditional IRA. However, Roth IRAs have income-eligibility limits that prevent some earners from leveraging their benefits. In 2021, the modified adjusted gross income (MAGI) of a single person must be under $140,000 to contribute to a Roth IRA. Individuals who are married and file jointly must have a MAGI of under $208,000.
Another tax strategy for retirement income involves postponing the need to take RMDs by investing in a special deferred annuity. A deferred annuity refers to a contract with an insurance company stating that the owner will receive a regular income or lump sum on a specified future date. Deferred annuities can help individuals who want to supplement their retirement income, such as their Social Security benefits.
A retiree can use up to $135,000 (maximum of 25 percent of their account balance) from their 401(k) or IRA to purchase a qualified longevity annuity contract (QLAC). Any funds that are allocated to the QLAC are exempt from RMD calculations.
Disclosure: Annuity guarantees rely on financial strength and claims-paying ability of issuing insurance company. Annuities are insurance products that may be subject to fees, surrender changes and holding periods which vary by carrier. Annuities are not FDIC insured.
Speak with an Experienced Wealth Manager About Tax Strategies For Retirement
There are many different tax burdens to be aware of during retirement. Working with a qualified wealth manager can help ensure that the proper tax strategies are executed to potentially minimize the amount of taxes paid each year. For more information about tax strategies for retirement income or to speak with an experienced wealth manager, contact Campbell Wealth Management.