It’s not just how much you save or even when you start saving. While death and taxes are certain, with careful planning you can have some influence on the latter — including when, how, and how much you pay. Here are some tax strategies you may not be familiar with that you can use to your advantage in retirement. Since “the best defense is a strong offense,” all of these require planning now so you can reap benefits down the road.
1. Spread Your Assets Around
Why does it matter which type of accounts — tax-deferred, taxable, or tax-free — you use to save for retirement? Asset location, or how you apportion your savings, determines what levers you have to manage for your post-retirement income. The more diversified your retirement assets are in terms of tax treatment, the greater the flexibility you’ll have to proactively manage your future tax burden — whether your goal is to reduce the amount of taxes you pay while in retirement or to maximize the amount of funds available to your heirs.
For example, in a higher income year, you might want to withdraw more from your tax-free accounts, such as Roth IRAs, to avoid taking withdrawals from your tax-deferred accounts that would bump you up to a higher tax bracket. But in years that you expect to have a lower income, it might make sense to pull more funds from your taxable accounts such as 401(k)s.
Pro Tip: Think of your retirement withdrawal strategy and tax planning as dynamic activities, not static “one and done” decisions.
2. Open A Spousal IRA Account
You don’t have to be working to open a tax-deductible IRA. Provided you meet eligibility criteria, and your spouse contributes to an IRA account, you can open a spousal IRA and receive a tax deduction. The IRS sets limits on who can contribute and how much can be contributed each year.
The maximum annual contribution limit is $7,000 for singles over the age of 50 and $14,000 for couples over the age of 50 who are married and filing jointly. For the 2022 tax year, deductions begin to phase out at income limits of $68,0000 for singles and $109,000 for married couples filing jointly.
3. Timing Is Everything
Reaching your 70s is definitely a gift. But it can cost you. Once you hit 72, you have to begin making required minimum distributions (RMDs) from your tax-deferred retirement accounts such as 401(k)s and deductible IRAs. The problem is doing that boosts your taxable income. The tax hit can be even more frustrating if you’re in a position where you don’t need the funds to meet your living expenses.
If you’re charitably-minded, one strategy for managing this could be to direct your RMDs (up to a maximum of $100,000 a year) directly to a qualifying charity. Qualified Charitable Distributions (QCDs), also known as charitable rollovers, allow you to satisfy your annual RMD and support the charity of your choice. It also avoids the tax hit you might take from the boost additional withdrawals give your annual income. Not bad, right?
Pro Tip: Converting pre-tax retirement assets, say from an IRA or a 401(k), to a Roth can save you money in the long-term. But be careful about converting too much at one time. You’ll owe taxes on amounts you convert in the year you make the conversion. Because of that, it often makes sense to spread your conversions out over time, taking into account all your retirement income sources (taxable and non taxable), your current tax bracket, and how you expect that to change in the future.
4. Relocating? Be Strategic About It
Where you retire can have a big impact on your overall tax burden. For instance, while most states impose an income tax, 37 states do not tax Social Security income. Though you may still owe federal taxes on a portion of your Social Security benefits, avoiding state taxes could mean big savings.
In states with income taxes, tax rates vary widely, from a high of roughly 13 percent in California to a low of about 3 percent in Pennsylvania. But these seven states do not impose an income tax at all:
- Alaska
- Florida
- Nevada
- South Dakota
- Texas
- Washington
- Wyoming
If you’re planning to split your time between different states when you retire, or between the U.S. and an international location, be careful. The U.S. taxes citizens on global income regardless of where that income is earned. While the U.S. has tax treaties with many countries designed to minimize double taxation, your tax residency (and ultimately how much tax you’ll be on the hook for) will be determined by, among other things, the substantial presence test. This test takes into account how much time you spend in each tax jurisdiction.
Pro Tip: Snowbirds look out! States have their own tax residency rules, and some are extremely aggressive about them. Staying even an extra day or not having proof of how many days you spent in a certain place can make a difference come tax time.
5. Wait To Claim Social Security Benefits
I remember happily singing along to the Rolling Stones’ lyrics, “Time, time, time, is on my side” when I was in my 20s. A few decades later, that doesn’t always seem to be the case. But when it comes to Social Security, it is very much accurate.
When you start drawing benefits determines how much you get. If you start claiming early, before you reach full retirement age — 67 for most of us — your monthly benefits will be permanently lower. Wait until after that and you will benefit from a bonus that increases each year, until you reach age 70. For women especially, waiting longer almost always makes sense (unless you are in poor health or have good reason to believe your life expectancy is below average). Thanks to our greater longevity, more time spent out of the workforce on caregiving, and the gender pay gap, we have a greater risk of outliving our retirement savings than men do.
How could claiming later affect your taxes? Social Security benefits are taxable, excluding the first 15 percent. If you claim benefits early, and have other retirement income sources, you could find yourself paying more in taxes than you would have had you waited to collect your benefits.
Pro Tip: If you claim Social Security retirement benefits early and regret it, you are allowed to make a one-time do-over. The catch is you have to, first, do this within 12 months of filing your initial application; and, second, repay all of the benefits you received up to that point.
Retirement planning is multifaceted. Managing taxes is only one part of the much bigger picture. While they are certainly important, tax considerations shouldn’t drive major decisions such as where you live, how and to whom you gift, and major investment decisions.
It’s probably obvious, but this isn’t an area to wing it. Regular planning with your tax expert and your financial advisor, if you have one, can help you anticipate your income and cash flow needs in retirement. A plan will help you come up with tax strategies to support you in creating the retirement you deserve.
Here are some other articles on preparing for and living well while in retirement: