5 tax planning tips for retirees
There’s a common misconception that, when you retire, your tax bills shrink, your tax returns become simpler and tax planning is a thing of the past. That may be true for some, but many people find that the combination of Social Security, pensions and withdrawals from retirement accounts increases their income in retirement and may even push them into a higher tax bracket.
If you’re retired or approaching retirement, consider these five tax-planning tips:
Develop a plan for drawing retirement income in a tax-efficient manner, being sure to keep state income tax, if applicable, in mind. For example, you might minimize current taxes by tapping nontaxable assets first, followed by assets that generate capital gains, and putting off withdrawals from tax-deferred accounts as long as possible.
On the other hand, if you’re approaching age 72 and will have substantial required minimum distributions (RMDs) from tax-deferred accounts when you reach that age (see No. 3 below), it may make sense to withdraw some of those funds earlier. Why? It can help you avoid having large RMDs that would push you into a higher tax bracket later.
For example, you might withdraw as much as you can from IRAs or 401(k) accounts each year without exceeding the lower tax brackets. That way, you keep current taxes on those funds at a reasonable level while reducing the size of your accounts and, in turn, the size of your RMDs down the road. You can obtain additional funds from nontaxable or capital gains assets, if needed.
Keep in mind that, if your income from other sources exceeds certain thresholds, your Social Security benefits will become partially taxable. For example, married couples filing jointly with combined income over $44,000 are taxed on up to 85% of their Social Security benefits. (Combined income is adjusted gross income plus nontaxable interest plus half of Social Security benefits.)
One strategy for reducing the amount of RMDs, at least if you’re charitably inclined, is to make a qualified charitable distribution (QCD). If you’re age 70½ or older (this age didn’t increase when the RMD age increased), a QCD allows you to distribute up to $100,000 tax-free directly from an IRA to a qualified charity and to apply that amount toward your RMDs.
The funds aren’t included in your income, so you avoid tax on the entire amount, regardless of whether you itemize. In addition, the income-based limits on charitable deductions don’t apply. Any amount excluded from your income by virtue of the QCD is similarly excluded from being treated as a charitable deduction.
If you are nearing retirement age and have questions on how your tax situation may change, contact one of our expert tax advisors.