4 Simple Strategies on How to Reduce Taxes and Maximize Retirement Income
February 10, 2024
Tax-savvy withdrawals in retirement are often overlooked or ignored by investors. That’s bad news when the Required Minimum Distribution (RMD) comes along and OUCH!
As individuals approach retirement or if they’re already retired, one of the key concerns is ensuring a stable and tax-efficient income stream during their golden years. While saving diligently for retirement is crucial, understanding and implementing effective tax strategies can make a significant impact on the amount of money you retain. In this article, we’ll explore a simple yet powerful strategy to reduce taxes on retirement income.
Diversify Your Retirement Accounts:
One of the foundational principles in minimizing taxes on retirement income is to diversify your accounts strategically. Different retirement accounts are subject to different tax treatments, and leveraging this diversity can work to your advantage.
Traditional IRAs and 401(k)s: Contributions to these accounts are tax-deductible, but withdrawals during retirement are taxed as ordinary income. By contributing to these accounts during your working years, you reduce your taxable income and potentially enter a lower tax bracket. Remember that RMD rule?
Roth IRAs and Roth 401(k)s: Contributions to Roth accounts are made with after-tax dollars, but qualified withdrawals, including earnings, are tax-free. Diversifying your retirement savings by including Roth accounts allows for tax-free income in retirement, providing flexibility to manage your tax liability. Do you have a Roth account?
Taxable Accounts: Contributions to taxable accounts give you more flexibility to withdraw money from each account according to your lifestyle, budget, and unexpected events from life.
The goal is to have all 3 accounts invested and maxed out by the time you reach retirement, but you have to keep investing and growing the account balances as well. See the graph below.
2. Strategic Withdrawals:
When it comes to taking money out of your retirement accounts, a well-thought-out withdrawal strategy can minimize taxes. Consider the following tactics:
Delay Social Security: If possible, delay claiming Social Security benefits until full retirement age or even later. This can maximize your Social Security income and reduce the need to withdraw from tax-deferred retirement accounts, allowing them to grow further.
Tax-Efficient Withdrawals: When it’s time to withdraw funds, aim for a tax-efficient sequence. There is not a one size fits all strategy when it comes to tax savy withdrawals. However, one approach is to start by drawing from taxable accounts, then tax-deferred accounts, and finally tax-free accounts. This approach allows tax-advantaged accounts to continue growing, while potentially keeping you in a lower tax bracket. It’s best to have a detailed plan put together from a fiduciary fee-only advisor to tailor to your specific lifestyle and generational planning. 10 Mistakes Investors Make Without Advisors
3. Tax-Loss Harvesting:
Take advantage of market downturns by implementing tax-loss harvesting. This involves selling investments at a loss to offset gains in other areas of your portfolio. By strategically managing your capital gains, you can minimize your overall tax liability, leaving more money in your pocket during retirement.
4. Consider Health Savings Accounts (HSAs)
If eligible, contributing to an HSA can provide a triple tax advantage. Contributions are tax-deductible, the growth is tax-free, and withdrawals for qualified medical expenses are tax-free. In retirement, when healthcare costs tend to rise, having a tax-efficient way to cover these expenses can be invaluable. This type of account is one of the best to fund during your accumulation years and can fit into the tax free bucket from the chart above.
Conclusion:
Implementing a simple strategy to reduce taxes on retirement income involves thoughtful planning and diversification. By strategically choosing where to save and how to withdraw funds, you can optimize your tax situation and retain more of your hard-earned money in retirement. It’s advisable to consult with a financial advisor to tailor these strategies to your unique circumstances and ensure a secure financial future. Remember, the key to a successful retirement is not just accumulating wealth but also making strategic decisions to preserve, maximize, and continue growing it.
If you would like a second opinion on your investment accounts or a review on your wealth strategy, please reach us at info@commonfinancialsense.com.
