Essential Tax Tips Every Retiree (and Pre-Retiree) Needs to Know

Retirement planning can be much more complicated than it first appears, and tax experts concur that this is a period when individuals should take extra care to consider all aspects of their finances before making decisions about things like when to start taking Social Security or how much money to withdraw from their 401(k).

Tax Considerations for Retirement Planning

The percentage of your Social Security income that would be taxed, for example, may climb significantly if you withdraw a sizable sum to pay down a mortgage.

Early withdrawal from a retirement account may potentially be subject to significant penalties or an unexpected tax bill.

Additionally, if you start getting Social Security payments earlier than necessary, you may end up earning significantly less each month than if you wait until you reach the maximum age of 70.

Positively, taxpayers 50 years of age and above still have time to make catch-up contributions to their regular or Roth IRA for the 2023 tax year. You must make catch-up contributions to your IRA by the deadline for filing your taxes (return extensions are not included).

According to Kathy Pickering, chief tax officer at H&R Block, taxpayers who are close to retirement can still make this catch-up contribution, which could boost their retirement benefits and lower their taxable income in 2023.

Tax Strategies for Retirees

Here are some top tax strategies for individuals planning to retire:

• Maximize Contributions to Retirement Accounts: One of the most effective ways to save for retirement while reducing taxable income is by contributing to tax-advantaged retirement accounts such as 401(k)s, IRAs, or Roth IRAs. Contributions to traditional retirement accounts are often tax-deductible, reducing taxable income in the year of contribution.
• Consider Roth Conversions: If you have a traditional IRA or 401(k), consider converting some or all of it to a Roth IRA. While you'll have to pay taxes on the amount converted in the year of conversion, qualified distributions from a Roth IRA in retirement are tax-free. This strategy can be particularly beneficial if you expect to be in a higher tax bracket in retirement or if you want to minimize required minimum distributions (RMDs) later on.
• Strategically Time Retirement Account Withdrawals: When you start withdrawing from retirement accounts, consider the timing to minimize tax liabilities. For example, delaying Social Security benefits and drawing down retirement account balances first can reduce taxable income early in retirement when you might be in a higher tax bracket.
• Use Tax-Efficient Investment Strategies: Opt for investments that are tax-efficient, such as index funds or exchange-traded funds (ETFs) that typically generate fewer taxable events compared to actively managed funds. Additionally, consider holding investments in taxable accounts that qualify for long-term capital gains tax rates, which are generally lower than ordinary income tax rates.
• Manage Capital Gains: Be mindful of the tax implications when selling assets such as stocks, bonds, or real estate. Consider utilizing strategies like tax-loss harvesting to offset capital gains with capital losses, thereby reducing your overall tax liability. Additionally, be aware of the holding period for assets to qualify for long-term capital gains treatment, which can result in lower tax rates.
• Plan for Required Minimum Distributions (RMDs): Once you reach age 72 (or 70 ½ for those born before July 1, 1949), you're required to start taking RMDs from traditional IRAs and 401(k)s. Failure to take these distributions can result in substantial penalties. Consider the impact of RMDs on your taxable income and plan accordingly to minimize the tax burden.
• Utilize Health Savings Accounts (HSAs): If you're eligible, contribute to an HSA, which offers triple tax benefits: contributions are tax-deductible, growth is tax-deferred, and withdrawals for qualified medical expenses are tax-free. HSAs can serve as a valuable tool for covering healthcare costs in retirement tax-efficiently.
• Plan for Estate Taxes: If you have a sizable estate, consider estate planning strategies to minimize estate taxes for your heirs. This might involve establishing trusts, gifting assets during your lifetime, or utilizing other estate planning tools to maximize tax efficiency.
• Seek Professional Advice: Tax laws are complex and subject to change, so it's crucial to consult with a tax advisor or financial planner who can help you develop a personalized tax strategy tailored to your specific circumstances and retirement goals.