Tax Strategies for Your Retirement Income

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Tax Strategies for Your Retirement Income

When you retire, your income typically comes from three sources: Social Security payments, distributions from IRAs and retirement plans, and monies from savings and other assets. Depending on your income, you may choose to use specific tax tactics in order to reduce what Uncle Sam collects from you in retirement. Here are a few to think about.

Key Takeaways

  • Most retirees depend on a variety of income streams, and there are methods to reduce taxes on each of them.
  • One of the most effective techniques is to reside in or relocate to a tax-friendly state.
  • Other techniques include repurposing assets to be tax-efficient and deferring payouts from retirement funds.
  • Don’t forget to plan ahead of time for Social Security: Benefits may be taxed based on your other income.

Live in a Tax-Friendly State

Living in or moving to a tax-friendly state is one of the greatest ways for saving taxes on retirement income. This will be particularly relevant in the aftermath of the Tax Cuts and Jobs Act, when only $10,000 in local property, state and local income, or sales taxes would be deductible for federal income tax purposes.

Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming are the only states that do not have income taxes. Only interest and dividends are taxed in New Hampshire and Tennessee.

Federal law prohibits states from charging citizens on retirement benefits obtained in another state. Thus, earning a pension in California or New York (high tax states) then retiring to Florida or Texas (no tax states) avoids state taxation on this income.

Other states may have low-income taxes or specific retired income tax benefits. Part states, for example, may not tax Social Security payments or some or all income from IRAs and retirement plans.

Reassess Your Investments

In retirement, you may wish to adjust your investment holdings, not only to reduce taxes, but also to protect principle. Here are a few possibilities:

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Municipal Bonds

Municipal bond interest is not subject to federal income tax, although it may influence the taxation of Social Security payments.

Dividend Stocks

Qualified dividends, which are basically normal dividends from publicly listed US firms as well as some overseas corporations, are taxed at lower rates than ordinary income. Depending on your taxable income, the tax rate may be zero, 15%, or 20%.

Losses That Offset Capital Gains

Losses on the sale of securities and other property may be used to offset capital gains, allowing you to pay no tax on the profits. Furthermore, if you have excess capital losses, you may deduct up to $3,000 in ordinary income (such as bank interest), and any further losses can be carried forward.

Avoid or Postpone RMDs

If you are at least 72 years old, you are not obliged to pay tax on required minimum distributions (RMDs) from your conventional IRA if the assets are transferred to a charity. The RMD used to be 7012, but it was increased to 72 after the passing of the Setting Every Community Up For Retirement Enhancement (SECURE)Act in December 2019. Here’s what you’ll need:

  • The monies must be sent directly to an IRS-approved public charity by your IRA trustee or custodian.
  • As with every charitable gift, you must get formal acknowledgement from the charity.

This approach has a $100,000 yearly restriction. If you are married, each spouse is limited to $100,000. This method is only applicable to IRAs, not IRA-type accounts like SEP IRAs or SIMPLE IRAs.

Roth IRAs are not subject to RMDs.

Due to the March 2020 enactment of the CARES Act, a $2 trillion stimulus adopted amid the economic impact from the COVID-19 pandemic, required minimum distributions for conventional IRAs and 401(k)s have been halted in 2020.

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Deferred Annuities

By investing in an unique delayed annuity, you may also postpone the need to take RMDs and assure that you will not run out of retirement income. You may utilize up to $135,000 from your IRA or 401(k) (but no more than 25% of your account balance) to purchase a qualifying longevity annuity contract (QLAC) inside the retirement account. RMD calculations do not apply to funds provided to the QLAC.

Payments from a QLAC are not required to begin immediately, but must begin no later than the age of 85. The payments are taxable to you, and the money from the QLAC meet the RMD requirements for this component of your IRA or retirement plan automatically.

Your complete retirement age varies from 65 to 67, depending on the year you were born.

Before starting, examine the disadvantages of a QLAC. There is no cash value that may be accessed prior to annuitization. This form of investment may have greater costs than others offered via an IRA or 401(k). In order to get the income, you must live to the specified age (e.g., 85).

Be Strategic AboutSocial Security Benefits

If you don’t need Social Security at full retirement age because you have other sources of income, consider deferring benefits until age 70. You will earn more credits to increase your monthly benefits at that time, and you will not be required to pay taxes on the benefits now.

When you get benefits, they are either entirely tax-free or contain 50% or 85% of your gross income, depending on your other income (including tax-free interest on municipal bonds).More precisely, if your provisional income (a phrase used to calculate the taxable share of Social Security benefits) is less than $25,000 for a single person or $32,000 for a married couple filing jointly, none of your Social Security payments are taxed.

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If you’re single and earn between $25,000 and $34,000 (or $32,000 and $44,000 if married filing jointly), 50% of your benefits are taxed. If your income exceeds $34,000 or $44,000, 85% of your benefits are included in your gross income. Married couples filing separately have 85% of their benefits automatically included in their gross income.

Because the part of your Social Security payments that is taxed is determined by your other income, strive to keep it as low as possible. Here are some ideas:

  • Lower your adjusted gross income (AGI).If you are still working, you may lower your AGI by contributing to deductible IRAs and 401(k) plans.
  • Securities sales should be limited. While sales should be driven largely by financial concerns, you may wish to restrict sales whenever possible so that your revenue does not push you over the 50% inclusion to the 85% inclusion.
  • If you have a Roth IRA, take withdrawals from it. Withdrawals from a Roth IRA are tax-free in retirement and are not included into the calculation of Social Security taxes.

The BottomLine

It is important to consider tax methods for your retirement income, but there is no one best plan. Each person’s particular circumstance is unique, thus a tax plan must be tailored to you. To learn more and create a tailored strategy, consult with a tax or financial professional.

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