Tips from Financial Advisors: How to Lower Taxes in Retirement

8 Tips from Financial Advisers for How to Lower Taxes in Retirement

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Written by Edmund Moy

Mar 11, 2022

For many of us, retirement will mean living on a fixed income. It stands to reason, then, that we may want to look for ways to keep as much of that income as possible. The good news is that years ahead of retirement, a prospective retiree may be able to take certain actions to help lower their potential tax burden and safeguard more money for their retirement. Here are eight tips from top financial advisors that I have found helpful for lowering taxes during retirement.

1. Contribute to Tax-Deferred Accounts.

Financial services provider Charles Schwab recommends looking into tax-deferred retirement accounts.

According to Schwab, contributions to these accounts—including 401(k)s, 403(b)s, and traditional IRAs—generally reduce taxable income dollar for dollar for the year contributions are made. Moreover, pretax contributions and gains are not usually taxed until retirement. At retirement, withdrawals are subject to ordinary income tax rates.

2. Explore Roth IRA or Roth 401(k) Options.

Charles Schwab points out, too, that unlike contributions to tax-deferred accounts, contributions to Roth 401(k)s and Roth IRAs are made with after-tax dollars. So the contributions will not reduce an individual’s current taxable income. However, when the money is accessed in retirement, a retiree will not owe taxes on appreciation, income, or withdrawals.

Charles Schwab emphasizes that a Roth IRA is exempt from required minimum distributions (unless you inherit it), while a Roth 401(k) is not.

One option for either a traditional or Roth IRA is a self-directed IRA. A self-directed IRA enables you to allocate IRA funds to alternative assets such as real estate and precious metals. Self-directed IRAs are available to everyone, even those with one or more existing retirement accounts.

3. Review the SECURE Act.

A federal law, known as the Setting Every Community Up for Retirement Enhancement (SECURE) Act, made several significant changes to IRAs. Some experts have called this “the biggest retirement-related legislation enacted in more than a decade, and [others] believe more reforms lie ahead.”

Financial services provider Putnam says these changes include:

  • Raising the age for required minimum distributions from IRAs to 72 from 70½. This affects people who are reaching 70½ after 2019.
  • Repealing the age limit for contributions to traditional IRAs. Under the law, people who have reached age 70½, or their spouses, can contribute to a traditional IRA as long as they have earned income. Previously, those over age 70½ were limited to contributions to Roth IRAs. This affects contributions made for tax years after 2019.

4. Consider a Health Savings Account.

Charles Schwab notes that a health savings account (HSA) can be a smart way to save for retirement. HSAs are available through employers and many high-deductible health insurance plans.

According to Charles Schwab, money put into this type of account grows tax-free, and withdrawals for qualified medical expenses are not taxed. Once an individual reaches 65 years old, withdrawals for nonmedical purposes are taxed as ordinary income. HSAs are exempt from required minimum distributions, though.

5. Live Where Retirement Distributions Are Not Taxed.

AARP, one of the best-known sources of information about maximizing retirement income, notes that 12 states don’t tax distributions from 401(k) plans, IRAs, or pensions. These states are:

  • Alaska
  • Florida
  • Illinois
  • Mississippi
  • Nevada
  • New Hampshire
  • Pennsylvania
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

6. Contribute to Multiple Retirement Accounts.

Putting money into several kinds of retirement accounts, rather than just one kind, diversifies your asset mix as well as your tax strategy.

“When you spread your savings across different types of taxable and nontaxable accounts, you give yourself flexibility in retirement to combine various streams of income in a way that allows you to minimize taxes and maximize income,” financial services provider Northwestern Mutual explains.

7. Make Catch-Up Contributions.

For 2022, the IRS allows various catch-up contributions for people 50 and over:

  • $6,500 for a 401(k) or 403(b)
  • $1,000 for a traditional or Roth IRA
  • $4,000 for a SIMPLE IRA or SIMPLE 401(k)

These catch-up contributions offer tax advantages.

“If you’re 50 or older, the catch-up provision can provide a great opportunity to contribute more to your retirement savings,” financial services provider Principal says. “This is especially true if you haven’t always been able to contribute the maximum amount in the past. The pretax contributions also allow you to reduce your current taxable income even further.”

8. Avoid Early Withdrawal Penalties.

While there are exceptions, tax penalties may be leveraged if money is withdrawn from an IRA before the account holder reaches age 59½.

Charles Schwab notes that contributions to a traditional IRA are taxed as ordinary income. But if an individual withdraws money from a traditional IRA before age 59½, they could be charged a 10% penalty. However, some exceptions apply. Some people may be able to avoid a penalty if they withdraw money for an eligible reason, such as a first-time home purchase or an unreimbursed medical expense.

An early withdrawal from a Roth IRA also might be taxed. If individuals take a distribution of Roth IRA earnings before they reach age 59½ and before the account is five years old, they might be charged taxes and penalties, Charles Schwab says. But just as with a traditional IRA, there are penalty exemptions for Roth IRA withdrawals, such as if someone is a first-time homebuyer or becomes disabled.

As you approach retirement age, it may be beneficial to examine all your options. All eight of these tips have been helpful to me, and I have already acted upon the seven that apply to my personal financial situation. Even if you choose not to act right away, exploring your options can help you gain a better understanding of what retirement income will mean for your own unique financial situation and how you might better prepare for retirement.

Different retirement accounts and retirement incomes are taxed differently. Request a complimentary Gold IRA Kit today to learn about one retirement account, the self-directed IRA.


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