What are your plans for retirement? Do you think that maybe you will sail around the globe with your special someone by your side? We all have wonderful plans for our retirement. That’s why we work so hard to save for it. Things like 401(k)s, IRAs, and other forms of personal savings and investments help pad that retirement nest egg.
The focus for most people is how to save as much money for retirement as possible. But there is one crucial aspect that many people forget about: how to keep the money they save.
It’s not all about learning to live within your means or finding the best investment opportunities (although these are very important). You also need to think about taxes. Yes, you still have to pay your taxes even after you retire. If you’re not smart about it, this is one thing that could drain your retirement fund faster than terrible spending habits.
How to Lower Your Taxes After Retirement
Before going any further, we want to mention that the tips in this article aren’t meant to help you avoid paying taxes (that’s illegal and ill-advised). These tips are little nuggets of knowledge to help people save more money by doing their taxes properly once they retire. That being said, here are some of the most effective ways to lower your taxes once you hit the retirement:
1. Wait Until 70 to File for Social Security Benefits
This might sound counterintuitive because most people retire at 65 or 67 years old. The only reason why anybody wants to pay into social security is so that they can enjoy these benefits during retirement. The problem with taking out benefits early (you can file and start claiming your benefits as early as 62 years old) is that you will get reduced benefits.
If you retire at age 67 and wait three more years until you are 70 before filing for your social security benefits, then those benefits will go up by a whopping 8%. This means that you will get more money from your social security payouts, and you can reduce your taxable income before you turn 70.
Your Social Security income is taxable. By delaying these benefits you are essentially reducing the amount of money that the government can tax you for. Remember though that this will also reduce your income, so if you do need these benefits sooner, don’t be afraid to use them. Not wanting to pay more taxes is not a reason to put yourself in a financial bind.
2. Use Partial Roth Conversion to Minimize the Effect of Tax on Your RMDs (Required Minimum Distributions)
One of the reasons why you’d want to delay claiming your benefits until you are 70 is because you’d essentially fall under a lower tax bracket. Once you turn 70 and a-half though, you must take what are known as RMDs (Required Minimum Distributions). This money will effectively increase your overall taxable income. To mitigate that, you can do something called a Partial Roth Conversion.
This means you transfer money from a traditional IRA and put it into a Roth Account. When you take this money out of your IRA and transfer it to a Roth Account, you will pay some taxes, but this allows you to spread out your tax payments over time.
RMDs typically trigger higher taxes, but with a Partial Roth Conversion, you will be paying smaller amounts in taxes every year until you turn 70 and a half. This essentially reduces your tax burden.
3. Manage the Taxes from Your Employer Pension
Some people receive pensions from their employers. This is not as common as it used to be, but people with a pension plan will want to manage their taxes. These payments might push you up into a higher tax bracket. This means that you’ll be parting with more of your money once you retire. Again, to manage the taxes that come with your employer pension, you can use a Partial Roth Conversion before these benefits kick in.
Pensions usually kick in at 65. Taking advantage of Partial Roth Conversions will usually help lower your tax payments. By the time your pension kicks in, your tax obligations will likely still be lower since you’ll have already paid on the conversions.
4. Use Your RMDs to Give Back to Charity
As we’ve already mentioned, you’ll be forced to take RMDs at age 70. This will likely bump you up into a higher tax bracket. However, contributing RMD earnings to charity, gives you a tax write-off. Not only that, but you’ll also feel good about yourself for being charitable, which is priceless!
Using your RMDs to make qualified charitable donations has two main advantages:
- Your RMD donations will be considered tax write-offs
- Your IRA will have time to mature and earn you more since your retirement age of 65-70 in compounded interests
This strategy leaves you with more money since you save a great deal from the tax write-off. It’s also being put to good use since you’re doing something kind for others.
These strategies can help you save on taxes if you plan properly for your retirement. If you don’t have a plan for retirement, or aren’t sure what to do, then it’s a good idea to consult a financial adviser. They can help you maximize your retirement distributions and help you set up the accounts that will best suit your needs.