For many people, the transition into retirement is full of possibility and excitement. Yet it can also be a time of apprehension and doubt—especially when it comes to achieving financial goals. In this article, we’re sharing five key tax planning strategies that can help maximize your retirement years.
No matter how well you prepare financially for retirement, there will always be challenges that threaten to set you off course. For example, many retirees are surprised by how dramatically their tax situation changes once they stop working.
In fact, about two-thirds of retirees say if they had to advise their younger selves on a financial matter, it would be to better understand how taxes affect their retirement savings, according to a recent Thrivent survey.
Fortunately, with the right tax planning strategies, you can minimize the impact of taxes on your nest egg, so you feel more confident about reaching your retirement goals.
If you’re nearing retirement, consider the following tax planning strategies:
#1: Diversify Your Savings and Investment Account Types
Generally, there are three types of investment accounts in which you can grow your retirement savings:
- Traditional (pre-tax) retirement accounts. You contribute funds before taxes, then pay ordinary income taxes on your withdrawals in retirement.
- Roth (after-tax) retirement accounts. You contribute after-tax dollars, then withdraw funds tax-free in retirement.
- Taxable investment accounts. You contribute after-tax dollars and pay taxes on capital gains when you liquidate your investments.
Naturally, each type of account has its advantages and disadvantages when it comes to various tax planning strategies. Thus, you may find that diversifying your investment funds across each type of account helps you develop a more tax-efficient retirement income strategy.
Plus, in higher-income retirement years when you’re in a high tax bracket, withdrawing funds from a Roth account helps you avoid paying additional income taxes. Meanwhile, you can draw on your traditional retirement or taxable accounts in lower-income years when you’re in a lower tax bracket.
#2: Consider a Roth Contribution or Conversion in Lower Income Years
In 2023, individual taxpayers with modified adjusted gross income (MAGI) above $153,000 (or $228,000 for married couples filing jointly) can’t contribute directly to a Roth IRA. However, if your income is variable, you may want to take advantage of lower income years by contributing to a Roth or considering a Roth conversion.
The IRS allows anyone, regardless of income level, to convert all or part of your traditional IRA funds to a Roth IRA. As a result, you pay taxes on any funds you convert in the tax year you make the conversion.
Any withdrawals you make in retirement are then tax-free, and you don’t have required minimum distributions (RMDs) like you would with a traditional IRA. Thus, when it comes to tax planning strategies, a Roth conversion can be valuable as you near retirement—especially if you expect to be in a higher tax bracket in your retirement years.
Keep in mind that Roth conversions can be complex and aren’t right for everyone. Be sure to consult a financial planner or tax expert before taking advantage of this strategy.
#3: Invest in Municipal Bonds
If you’re approaching retirement, it’s often a good idea to increase your liquid cash reserves so you can still cover near-term expenses if there’s a market downturn. However, depending on where you keep your cash—for example, a money market or short-term bond funds—you may end up paying taxes on any interest you accrue.
The interest on municipal bonds, on the other hand, is exempt from federal income taxes (although you may have to pay state and local taxes, depending on the bond issuer and where you live). Therefore, investing your cash in municipal bonds can help you grow your cash reserves while generating a tax-free stream of income in retirement.
A financial professional can help you determine if this is one of the tax planning strategies that makes sense for you.
#4: Relocate to a Tax-Friendly Area
Many retirees choose to relocate or split their time between two places to reduce or eliminate their state income tax bill. For example, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming have no state income tax.
In addition, different states also provide different incentives and assistance programs for retirees, such as property tax exemptions, senior Citizens’ Credit Programs, or Elder Care services. Meanwhile, countries like Costa Rica and Portugal are tax-friendly retirement destinations and also boast lower costs of living.
If you retire in a state that has a high state income tax rate, establishing a residence in a tax-friendly location or relocating altogether may be one of the tax planning strategies you want to consider. In most cases, you’ll need to spend at least 183 days of the year in your alternate home for the IRS to consider it your permanent residence.
#5: Consider Two Additional Tax Planning Strategies: Catch-Up Contributions and/or a Spousal IRA
Lastly, for some couples, catch-up contributions and a spousal IRA can be effective tax planning strategies as you near retirement.
If you’re age 50 or above, you can make catch-up contributions to your employer-sponsored retirement plan and IRA(s). In 2023, you can contribute an additional $7,500 to a 401(k) or 403(b) plan. Meanwhile, you can contribute an additional $1,000 to a traditional or Roth IRA.
Separately, the IRS requires individuals to have earned income to contribute to an individual retirement account (IRA). An exception to this provision is a spousal IRA, which allows a working spouse to contribute to an IRA in the name of the non-working spouse.
A spousal IRA can be beneficial in that it essentially allows you to double your IRA contributions each calendar year. At the same time, you can deduct these contributions from your taxes in the year you make them, lowering your overall tax bill.
Keep in mind there are certain limitations and income requirements to qualify for a spousal IRA. Be sure to consult the IRS’s website or a financial professional to see if a spousal IRA is one of the tax planning strategies that makes sense for your retirement plan.
Satori Wealth Management Can Help You Take Advantage of These Tax Planning Strategies as You Near Retirement
The average retirement lasts 18 years, according to data from the U.S. Census Bureau. Unfortunately, excessive taxes can quickly eat away at your retirement savings if you don’t prepare accordingly.
Indeed, these are just a few examples of tax planning strategies that can help you minimize your tax bill in retirement. An experienced financial professional can help you develop a comprehensive plan that helps you leverage various tax planning strategies and preserve your nest egg long-term.
Satori Wealth Management has been leading clients through the retirement planning maze for 20 years. If you are approaching retirement and would like to speak with us about securing your financial future, we invite you to schedule your free RetireNow™ Checkup today.
Danny G. Michael is the founder and CEO of Satori Wealth Management, Inc. He has 20 years of experience in retirement planning working with individuals, families, and business owners.