Minimizing Taxes in Retirement

Whether you are nearing retirement age, or are just beginning to save, you likely have taxes on your mind. It is even scarier to think that the precious money you do save will be depleted by taxes. This leads many people to question how they can reduce taxes in retirement.

“As enticing as a completely tax-free income stream may sound, however, it’s difficult to create,” states Paul O’Donnell from CNBC. “The most common retirement savings vehicles, tax-deferred IRAs and 401(k)s, are unwieldy investments when it comes to taxation. And while most retirees have less income to tax, they also have fewer deductions, reducing the opportunities to shelter their reduced revenue.”

Almost everyone is familiar with the fear of not having saved enough to retire on time or comfortably.Some financial experts recommend that people in their 50s and 60s do serial Roth conversions before they hit the age (70 1/2) when they must withdraw from non-Roth accounts. Taxes will be paid on the money at the time of the conversion, whereas it would have been paid during retirement if the money was still in a pre-tax IRA. If you spread these conversions out over several years, you won’t be hit as hard by the tax bill.

Having your savings in a Roth account means that you won’t be required to take minimum distributions. When you do use money from your Roth IRA, it isn’t taxable. Keeping taxable income down also helps save on Social Security taxes.

“Generally, you want to make sure the income you realize from the conversion doesn’t bump you into a higher tax bracket,” states Ashlea Ebeling, Forbes staff member. “Conversions from a SIMPLE IRA work pretty much the same as conversions from a traditional IRA to a Roth IRA. One catch: you cannot convert any amount distributed from the SIMPLE IRA during the two-year period beginning on the date you first participated in any SIMPLE IRA plan maintained by your employer.”

If you use this method, you can significantly reduce the amount of taxes you will have to pay during retirement.

“Some financial advisors question whether avoiding taxes should be a priority at all in retirement planning,” states O’Donnell.

In reality, the most beneficial plan is to maximize the amount that you have in retirement. This might mean making investments that will be taxed, if those investments have the potential to give you a higher yield after taxes are taken out than a tax-free investment.

“But there’s good reason to pursue as much tax-free income as possible,” states O’Donnell. “At a time of life when returns are low and health-care expenses are high, it makes sense to preserve every retirement dollar you can.”

So, the bottom line is that you shouldn’t choose investments just because they are tax-free. Talk with your financial advisor to determine the after-tax yield of all your potential investments. With that information, you can determine how to round out your investment portfolio with tax-free investments to give yourself the most comfortable retirement possible.


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