Whether you’re just easing out of the workforce or you’ve been in retirement for a few years now, making the right financial moves is critical. If you’re working with an advisor or taking a look at your finances yourself, one central goal during retirement is protecting your wealth from unnecessary taxes.
In many cases, there are ways to avoid owing more taxes - but usually, this requires proactive action beyond tax season. Below I'll explain five tips you can utilize throughout the year to help minimize your tax obligations in retirement.
Tip #1: Take Your Required Minimum Distributions (RMDs)
An RMD is an amount that must be withdrawn from your retirement account. These required withdrawals begin when you, the retirement plan account owner, reach age 72. The rules apply to employer-sponsored retirement plans, traditional IRA plans and Roth 401(k) accounts, but they don’t apply to Roth IRAs when the account owner is still alive.
There are some things to consider. There is a 50% tax penalty on the amount you are required to take each year but didn't so taking the correct amount on a timely basis is one thing we make sure is completed each year. Also, if you are still working at a job with a 401(k) and over 72, there is no requirement in taking an RMD. This does not preclude you from having to take your RMD from other plans though.
Some IRA custodians and retirement plan administrators might find out what your RMD is for you, but the responsibility ultimately falls on you. (That's why we calculate it). If you are not working with an advisor, you can find out what your RMD is. The IRS provides life expectancy tables to utilize according to your circumstances. As I mentioned, If you do not withdraw the RMD, the amount not withdrawn will be taxed at 50 percent, which is why it’s critical to take your RMDs and withdraw the correct amount.1
It’s important to note that as part of the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, passed on March 27th, 2020, RMDs are not required for the remainder of 2020.2
If you already took your RMD for 2020 and you don't need it, you can possibly reverse it and save some taxes.
Tip #2: Manage Your Income Combinations
As a retiree, a portion of your income will likely come from Social Security. However, not all of your benefits are taxable, and there are ways to minimize or, at times, eliminate taxes on your Social Security benefits.
If half of your Social Security benefits in addition to your other income is higher than the base amount for your status, your benefits will be taxable. By strategically managing all of your income sources (such as pension payments, dividends or part-time jobs), it’s possible to lower the portion of benefits that will be taxed. Rules regarding Social Security income taxes also vary from state to state, so always check with your state regulations to determine the best solution for you.3
Tip #3: Figure Out if You Need to Pay Quarterly Taxes (If Not, You May Decide to do it Anyway)
If you don’t have taxes withheld automatically, you may need to pay estimated tax payments. Individuals who are expected to owe $1,000 or more - or those whose withholding and refundable credits are 1) less than 90 percent of the tax owed or 2) at least 100 percent of the tax on the previous year’s return - must pay estimated tax.
In some cases, you might decide to pay quarterly taxes, even if you are not required to, in an effort to avoid the inconvenience of paying a large sum all at once. If you miss a payment or underpay, you may be charged a penalty.4
Tip #4: If You’re Moving to a New State, Get to Know Its Tax Laws
If you’re relocating to a new state during retirement, consider the impact of the move on your financial situation, as tax laws vary according to the state. For example, some states, like Florida and New Hampshire, don’t tax on income or only tax on dividends and interest.5 On the other hand, they may have higher property taxes. For example, New Hampshire’s property taxes are high compared to the rest of the country.6 In addition to nicer weather or a more serene lifestyle, you might decide to move to a new state in an effort to save on taxes.
Tip #5: Roth IRA Conversions
A Roth Conversion is when you take some or all of your traditional IRA and convert it to a Roth IRA. You will pay taxes today on the conversion however; the "new Roth IRA" would then become a tax free asset (assuming the rules are met). The other advantage of a Roth conversion is those pesky RMD's I mentioned earlier go away. There are many factors at play when deciding to do a conversion and they aren't all tax related so it is important to discuss this strategy with your financial and tax advisor.
In many cases, an individual or couple is working with a fixed amount of wealth to last throughout retirement, which is why taking the right financial steps is essential. By working with an advisor and keeping these five tips in mind during the year, you can make sure you’re not paying more than you need to. When it comes time to finalize gifting to your children or grandchildren, you can further reduce taxes by incorporating other strategies, like charitable giving, into the equation. 7
We are here to help.
In good health.
All the best.
Rick Fingerman, CFP®
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.