How to Pay Less Taxes in Retirement

Who Benefits from Tax Planning?

The opportunity to pay less in taxes is greater for the following individuals:

• Those who have savings in tax-deferred retirement accounts, such as 401(k) accounts or Individual Retirement Accounts (IRA), and after-tax savings, such as a brokerage account.
• Those who have years when their income may be lower, such as when one spouse retires mid-year, or when married couples retire in different years, or when one spouse experiences a period of unemployment, or when income changes due to a commission-based job.
• Those who have years when their itemized deductions may change, such as when dealing with a new loan, paying off a loan, or when they have a year marked by increased medical expenses or charitable contributions, or when they gain new dependents.

Note: Your total itemized deductions may not exceed the standard deduction for your tax situation. It would be unproductive to itemize in this case as you would pay taxes on more income than you should.

How to Calculate Retirement Taxes

As you plan for retirement, it’s important to consider how your Social Security benefits will be taxed. Effective tax planning before retirement can give you the opportunity to reduce the amount that will be taxed on your Social Security benefits.

According to the Internal Revenue Service (IRS), you may need to pay income tax on a portion of your Social Security benefits. The taxable amount depends on your tax situation and your total income, including income from other sources such as pensions, wages, and capital gains.

You must add half of your Social Security income to your other total income to determine if you exceed the threshold set below based on your tax situation.

Up to 50% of your benefits may be taxable if your tax situation is Single, Head of Household, or Qualifying Widow(er) and you have income – including half of your benefits – between $25,000 and $34,000, as of the 2021 tax year (return filed in 2022).

This rule also applies to some married couples who file separate returns if they did not live with their spouse at any time during the tax year.

Up to 50% of benefits may be taxable for married couples filing jointly if their total income is between $32,000 and $44,000.

Up to 85% of your benefits may be taxable if your tax situation is Single, Head of Household, or Qualifying Widow(er) and your total income exceeds $34,000, as of the 2021 tax year (return filed in 2022).

Up to 85% of benefits may be taxable for married couples filing jointly if their total income exceeds $44,000.

Note: The limit of $34,000 increases to $44,000 if you are married and you and your spouse file a joint return.

Tax Saving through Tax Planning

Two types of tax planning can help you reduce retirement taxes and increase your after-tax income in retirement:

• Long-term tax planning provides general guidance on how much you should withdraw from your accounts year to year and how to coordinate your amounts with your Social Security income to reduce taxes.
• Annual tax planning addresses how tax rates and deductions change each year. Annual tax planning conducted in the fall may reveal opportunities that can’t be detected through long-term tax planning alone.

Planning

Long-Term Tax Planning

Long-term tax planning looks at your expected tax rates and sources of income. It shows how you can rearrange your income sources to achieve more after-tax income.

This type of planning requires a program or schedule that includes detailed tax calculations to show you the amount of after-tax income you can obtain by taking one action versus another. Long-term tax planning helps reduce your retirement taxes in two ways:

• You can design a general strategy on when to withdraw money from any type of account to keep yourself in the lowest possible tax bracket.
• It can show you how to allocate investments across your tax-deferred accounts versus your after-tax accounts to reduce the tax burden over your retirement years.

Annual Tax Planning

Annual tax planning can help uncover opportunities for you:

• Withdrawing money from an IRA or converting traditional IRA funds to a Roth IRA and paying little or no taxes in years when your deductions are high and other sources of income are low.
• Realizing capital losses to offset capital gains or creating a capital loss campaign. Use years characterized by high detailed deductions to your advantage. Fund the right type of account – Roth IRA, Traditional IRA, or 401(k) – that will provide you with the greatest long-term tax benefit based on your tax situation for that year.

Note: In 2022, tax rates range from 10% for income under $10,275 (11,000 in 2023) to 37% if over $539,900 (578,125 in 2023). These income thresholds are subject to annual inflation adjustments.

Get Help with Retirement Tax Planning

Smart tax planning is difficult to do without professional help. Remember when seeking assistance that many individuals who call themselves financial advisors work for large investment firms or banks that prevent them from providing tax advice.

Look for a certified public accountant (CPA) or a tax professional with a PFS designation who does the type of long-term tax planning you are looking for or an independent retirement planner. They should have a background in taxes and a process to identify tax planning opportunities. “PFS” stands for Personal Financial Specialist or personal finance planning specialist.

Frequently Asked Questions (FAQs)

What is the best way to save on taxes in retirement?

Understanding your retirement income sources and how they are taxed can save you money. You cannot predict your tax rate in retirement because your income and tax laws may change, but forecasting your income can help.

From there, you can assess what is taxable versus non-taxable and your tax deductions. Then, steer the most tax-efficient accounts for your money, when withdrawals should occur, and how much to withdraw. Consult a tax professional to assist you.

How should you estimate your future tax bracket in retirement?

That depends on how you expect your income to change. If you are early in your career and not earning much, you may be in a higher tax bracket in retirement. Conversely, if you are already in a high tax bracket, retiring may decrease your income and move you to a lower tax bracket.

Was this page helpful?

Thank you for your feedback!

Source: https://www.thebalancemoney.com/how-to-pay-less-taxes-in-retirement-2388972