Retirement brings about many changes including new routines, new adventures and possibly, a new tax bill. While everyone can benefit from lowering their tax liability, retirees especially should understand the tax implications of their financial decisions as they adjust to changes in income and expenses.
Before retirement, your goal was likely to save, grow and protect your money so you could retire with financial peace of mind; however, like many retirees, you may not have considered how your choices in retirement may affect your nest egg. For example, every dollar saved in a tax-deferred plan, such as a traditional IRA or 401(k), is taxed at the time funds are withdrawn. This means timing your withdrawals to reduce your tax liability can be crucial and can have an impact on your savings, as much as the investment choices you made prior to retirement.
John J. Brais, a financial planner, family wealth counselor and owner of Horizon Financial Services, LLC, shares five ideas you should consider to help minimize taxes (and maximize your savings) in retirement.
1. Put Your Tax Return to Work
First, it’s important to understand that your tax return and financial plan should work together. A well-constructed financial plan considers your long-term approach to tax planning and uses that approach in your investment planning. This helps you to make strategic and well-timed decisions that are aligned with your goals, including a goal of lowering your tax bill. Your financial plan should be dynamic and include plans for changes in income over time while taking advantage of various tax opportunities that occur throughout the year. Tax laws are perpetually changing, which makes understanding how to leverage them to your advantage difficult at best but reviewing your tax return during your financial planning process is a good way to identify areas for tax savings.
2. Know Your Marginal Tax Rate
In the U.S, our tax system is progressive, which means your income can fall into more than one bracket and be affected by more than one tax rate. Your marginal tax rate is the highest bracket and associated rate that applies to your income. Knowing your marginal tax rate can help you make informed and timely decisions about your investments so your income will fall within a preferable tax bracket, resulting in lowered taxes. Flushing out long-term capital gains or a well-timed Roth IRA conversion are examples of this strategy that can help affect your marginal tax rate. An investment’s qualified or ordinary dividends may also impact your ability to save taxes but above all, proper planning and organization are key strategies to taking full advantage of your marginal tax rate.
3. Bundle Your Deductions Bi-annually
When you pay income taxes each year, you can choose to take a standard deduction, which reduces the amount of income you pay taxes on or you can choose to itemize your deductions. Itemized deductions are expenses allowed by the IRS that decrease your taxable income. Depending on your situation, bundling your deductions bi-annually and alternating between the two types of deductions may help lower your tax bill.
With this strategy, it’s important to focus your planning on more than one year at a time. For example, if you pay property taxes, consider paying two years of property tax in the same year – one for the current year and one for the following year – and itemize your deductions. The next year, since your property tax payment was fulfilled in the previous year, you would choose the standard deduction. This strategy could also be used for medical expenses.
As you might imagine, deliberate and careful planning is critical to properly use this strategy and you should consider all of your gifting and charitable donations as well as other applicable deductions that may apply.
4. Maximize Your Retirement Account Contributions
Avoid the common mistake of waiting until tax time to contribute to your retirement account. (Yes, you can still contribute to a retirement account even in retirement depending on household active income and the type of account.) Properly timing your contributions to a retirement account like a traditional IRA, Roth IRA, among others, will help you maximize the performance of your account and participate in tax savings too.
For anyone still preparing for retirement, this strategy also applies to employer-based plans such as 401(k)s and 403(b)s. Employees typically make salary deferrals throughout the year but consider being more aggressive with your contributions earlier in the year if a lower net income will meet your needs. Your employer’s plan document will determine your ability to employ this strategy and may not be viable if it negatively affects your opportunity to receive employer-matched contributions. Pay close attention to your contributions the year you turn 50, when you may be allowed to contribute a higher amount based on catch-up amounts.
5. Time Your Withdrawals Carefully
Similar to making contributions, timing withdrawals from tax-deferred accounts like traditional IRAs, Roth IRAs or SEPs should be carefully considered and planned. Instead of taking a withdrawal from one of these accounts at the end of the year, you may benefit from taking a partial distribution at the end of one year and a second partial distribution at the beginning of the next calendar year, splitting (or sharing) your tax liability for the withdrawal over two taxable years.
If you are transitioning into retirement and expect to be at a lower tax rate next year, consider postponing withdrawals from your pre-tax retirement accounts until the new year when your income will be taxed at the lower tax rate. If you need funds now, check with your financial advisor to see what alternatives you have.
Not Sure How to Proceed?
Navigating tax laws can be extremely complicated and choosing the wrong strategy can be harmful to your planning process, costing you time and money. If you don’t currently work with a financial planner, consider a fiduciary that specializes in retirement and income planning. Fiduciaries are required to put your interests ahead of their own, which should bring you some financial peace of mind. In addition to experience, an in-depth understanding of the intricacies of income planning and tax strategies for your particular situation is also important. A seasoned tax professional can also play an important role in your planning process so we recommend choosing professionals that can work together to create a comprehensive financial plan that adheres to your long-term goals and considers the tax consequences of your investment decisions. Lastly, your financial plan should be dynamic – growing and changing with you as your needs and desires change over time, before and after retirement.
About Horizon Financial Services, LLC
Horizon Financial Services, LLC is an independent fiduciary planning firm focused on transparency and putting the best interests of their clients first. Their team of experienced financial planners and family wealth counselors helps hundreds of individuals effectively manage their wealth and plan for retirement. Horizon Financial can help you do the same with their customized holistic plans, which include allocating your investments based on your individual needs and providing you with ongoing financial planning services, which include wealth management, retirement and income planning, tax minimization strategies and legacy building. As part of their comprehensive financial planning process, they will collaborate with your tax planner, attorney and other chosen professionals as well as your beneficiaries to help ensure a cohesive, long-lasting and dynamic financial plan.
Horizon Financial Services, LLC, was established in 2011. Advisory services are offered through Horizon Financial Services, LLC, an SEC Registered Investment Advisor. Insurance products and services are offered through New Horizon Financial Services Inc., an affiliated company. Horizon Financial Services, LLC and New Horizon Financial Services Inc. are not affiliated with or endorsed by the Social Security Administration or any government agency.
This article is for informational purposes only. Please consult your financial advisor and tax professional for specific advice about your particular situation.