No matter how much you save, taxes can threaten your retirement nest egg. Many retirees find the tax impact on their retirement savings is more than anticipated, which can shake financial confidence and stability. Those who have been strategic in mitigating their tax burden will feel tax effects less than those who haven’t, and any experienced financial advisor would impart the sage wisdom that a robust tax plan is the best way to reduce taxes on wealth. Read on to learn more about strategic ways savers can manage their tax obligations.
The Importance of Tax Planning in Retirement
According to a 2023 survey by the Insured Retirement Institute, nearly half of retirees underestimated the impact taxes would have on their income. With limited retirement income streams primarily stemming from Social Security and retirement accounts, preserving wealth becomes paramount. Retirement can last 20 to 30 years, and outliving savings is not ideal, especially in later years when retirees need it most. Smart tax planning helps retirees optimize their Social Security benefits, avoid penalties, and manage required minimum distributions (RMDs) while enabling them to take advantage of charitable contributions, Roth conversions, and tax-efficient investment vehicles. A financial advisor can assist savers in creating a tax plan that anticipates changes in tax laws and income levels for greater stability and economic freedom in retirement. Here are some things they might suggest.
Maximize the Benefits of a Roth IRA
Rolling over funds from traditional 401(k) and IRA accounts to a Roth IRA (also known as a conversion) is a popular method of minimizing taxes for retirees. Contributions to traditional retirement accounts are made with pre-tax dollars, which means withdrawals from these accounts are taxed. Roth IRA account contributions are made with after-tax dollars, so qualified withdrawals in retirement are tax-free. This can benefit those who anticipate being in a higher tax bracket in retirement. For example, an individual in the 22% tax bracket now who expects to be in the 28% bracket post-retirement saves money by paying tax on contributions today at a lower rate. This saves money in the long run. However, there are a few important rules and considerations.
- The account holder will pay tax on the money they convert the year of the switch, but future withdrawals from the Roth IRAs can be tax-free.
- Roth IRA accounts must be at least five years old to qualify for tax-free withdrawals on earnings.
- The account holder must be 59 ½ or older.
- The contribution threshold is $7,000 in 2024 ($8,000 for individuals age 50 or older), but eligibility phases out based on income levels.
Explore Tax-Advantaged Investments
Some investment products are specially designed to provide tax benefits, making them essential to an effective and tax-efficient retirement strategy. Retirees can shield some assets from excessive taxation by diversifying their portfolios to include these investments. A few tax-advantaged products include:
- Municipal bonds: State and local governments issue these bonds to fund public projects like schools, roads, and utilities. These bonds are low-risk, produce stable returns, and offer tax-exempt interest income.
- Real estate investments: Real estate can afford tax breaks in a few ways. Depreciation deductions decrease taxable income by accounting for property wear and tear. Additionally, a 1031 exchange allows investors to reinvest proceeds from a property sale into a similar investment property, postponing capital gains taxes, preserving wealth, and fostering growth.
- Annuities: Tax-deferred growth on investment is the key reason annuities are part of a successful tax strategy. Investments compound without immediate tax liability, and individuals can manage their taxable income with strategically timed withdrawals, which produce a steady income stream while mitigating tax burden during retirement.
With the help of a financial advisor, investors can identify the best combination of investments for their risk tolerance and capacity while avoiding the pitfalls associated with each.
Charitable Giving as a Tax Strategy
Taxpayers may be surprised to learn that a way to save money is to give it away. Charitable giving allows taxpayers to support the causes that are important to them while minimizing their tax burden. Charitable contributions can reduce three types of federal taxes: income, capital gains, and estate. In 2024, taxpayers can donate up to 60% of their adjusted gross income in cash contributions. The IRS allows deductions for cash and noncash donations according to annual guidelines.
Qualified Charitable Distributions (QCDs): Individuals 70 ½ and older can transfer donations tax-free directly from an IRA to a charitable organization. QCDs also count toward the required minimum distributions (RMDs) that begin at age 73, which can lower taxable income. A $10,000 donation through a QCD eliminates taxes on that portion of an RMD, saving $2,400 for an individual in the 24% tax bracket.
Why Choose a Financial Professional?
Working with a financial advisor who knows the intricacies of tax planning is integral to attaining the best possible strategy for your Retirement Road Map®. Advisors assist clients in creating and managing their current tax plan, but they also proactively anticipate and adjust for tax liabilities that arise as income sources change in retirement.
Taxes shouldn’t derail your retirement lifestyle. At SHP Financial, we’ll help protect your savings and maximize your income using tried-and-true methods and decades of experience in tax planning. Contact us today for a complimentary review of your finances and discover how we can help you achieve a more secure financial future.