You’ve spent decades building a retirement nest egg, and now your career has come to an end. You’ve used a variety of tax preferential savings vehicles, including employer sponsored retirement plans and individual retirement accounts, or IRAs. You might have squirreled away some additional after-tax savings, too. Now you’re retired and think there’s nothing left to do other than enjoy your retirement.
Not so fast.
“Many variables impact tax planning for this group,” says David McKelvey, CPA and partner with Friedman LLP. He sees retirees between the ages of 62 and 70, advising them to take advantage of tax optimization strategies to preserve the value of their nest egg.
Read on to learn about several tax-savvy retirement strategies that can help you hang on to your money longer.
The U.S. tax system is a progressive one, with federal income tax rates ranging from 0% to 39.6%. While retirees, especially those with paid-off mortgages, may not need large amounts of income to sustain their lifestyles, they can protect their savings by minimizing income tax liabilities.
“Retirees should not leave room in the lowest tax brackets,” says Waldean Wall, vice president of advanced markets for Allianz Life.
Trigger taxable income
To take advantage of the opportunity to “top off your bracket,” retirees should trigger taxable income equal to the amount of room left in their tax bracket. For example, a couple filing jointly with $40,000 of combined income falls in the 15% bracket, which tops out at $75,300. They can earn another $35,300 before the next bracket applies, not counting the standard deduction or personal exemptions, which would add room for another $20,700.
One strategy involves “anticipating required minimum distributions from retirement plans that could push them into a higher tax bracket in future years,” says Wall. By taking distributions before age 70 1/2, more income can be legally shielded from potentially higher taxes when it’s time to take RMDs. Plus the income could sustain the couple’s lifestyle, enabling them to delay drawing Social Security until a later age, when benefits are larger.
However, McKelvey warns, such strategies should be done in concert with comprehensive investment planning.
Retirees should take advantage of preferential tax treatment given to long-term capital gains and qualified dividends. Long-term capital gains (i.e., the gains recognized when securities held for longer than one year are sold) are taxed at lower rates than ordinary income. Taxpayers in the 10% and 15% tax brackets are not subject to long-term capital gains tax at all — their rate is 0%. Taxpayers in the middle tax brackets are subject to this tax at 15%, and those at the highest tax bracket of 39.6% will see long-term capital gains taxed at 20% — roughly half of the ordinary income tax rate.
But it’s possible to dodge even the lower capital gains rate. Retirees who plan to sell stock to fund their living expenses should determine whether a more favorable tax strategy could be employed. Instead of selling stock with significant untaxed appreciation that could trigger long-term capital gains tax, retirees could consider tapping funds that generate no taxes, such as a Roth IRA.