Best Tax Strategies for Retirees

If you are one of the many retirees out there who are worried taxes can impact the future of your financial circumstances, then this guide is for you. According to the 2022 Thrivent Retirement Readiness Survey*, nearly two-thirds of retirees express a desire to have advised their younger selves about understanding the role of taxes in retirement savings. This is just the start of it. If you’re looking for tax strategies for retirees, then you should keep reading!

The Best Tax Strategies for Retirement

With the specter of potential tax increases on the horizon, due in part to factors like the $336 billion federal deficit as of October 2022, taking proactive steps in your retirement tax planning can be a smart move. Utilizing the current, historically lower tax rates becomes a useful instrument for generating savings for the future.

The concept of categorizing assets into “tax now, tax later, tax never” buckets, as explained by Todd Yeiter, Director of Advisor Support, can serve as a guiding principle.

Strategically Optimizing Tax Efficiency in Asset Management

A careful structure of assets is required when creating a tax-efficient approach to maximize their tax benefits. This includes a wide range of financial instruments, such as Social Security payouts, mutual funds, and life insurance plans.

Smart Management

The wise management of these assets may result in a decrease in state income tax liabilities, thus improving your overall financial situation. Aligning your financial and retirement goals with the goal of reducing tax liabilities becomes crucial when considering the potential tax implications of withdrawals and distributions.

You have the chance to create a thorough and tax-optimized financial blueprint that meets both your current and long-term financial goals by wisely allocating and managing your assets.

You can optimize your retirement resources and perfectly line them with your long-term financial goals by developing a well-defined tax strategy.

Here are a few wise tax deductions to include in your retirement savings strategy.

Harness the Benefits of the Roth IRA Advantage

Are you foreseeing that your prime earning years are yet to come, potentially leading you into a higher tax bracket as retirement approaches? “A common trend we observe among families—those with dual incomes, children, and mortgages—is that they often find themselves in the 12% tax bracket, for instance, while contributing to pre-tax accounts,” explains Ron Lutes, Advice Services consultant at Thrivent. “However, as they near retirement, their tax bracket might escalate to 22% or even 25%.”

Incorporating a Roth IRA into your savings strategy could be a prudent move. A Roth IRA is funded using money you’ve already paid taxes on, known as after-tax dollars.

While contributions to Roth IRAs don’t yield a tax deduction, the earnings within the account grow tax-free, placing them in the “tax never” category.

Moreover, qualified withdrawals from a Roth IRA come with no tax liability. Another advantage is that Roth IRAs aren’t subject to mandatory minimum distributions (RMDs), which is a requirement for many other retirement savings accounts.

Both traditional and Roth IRAs have annual contribution limits defined by the IRS each year. Additionally, if you’re 50 or older, catch-up contributions on a variety of retirement plans might be a useful tool. They give your savings a boost by allowing you to contribute more than the annual cap.

Contribution Limit for 2023: $6,500

Catch-Up Limit for 2023: $1,000

Starting in 2024, IRA Catch-up Contribution Limits will Increase in $100 Increments

It’s worth noting that Roth IRAs have income thresholds for participation. You’re eligible to contribute to a Roth IRA if your monthly adjusted gross income (MAGI) for 2023 falls below $153,000 (single filer) or $228,000 (joint filer).

Already Have a Traditional IRA? Consider a Roth Conversion.

If you’re currently holding a traditional IRA and are intrigued by the idea of a Roth IRA, a Roth conversion might be worth considering. This strategy can help you evade the income tax implications of required minimum distributions (RMDs) once you reach retirement age, potentially resulting in a tax advantage (given the current lower rates). Qualified distributions from Roth IRAs are tax-free.

Experts recommend having a component [within a portfolio] that has the potential to remain untaxed in the future. One of the prime benefits of a Roth IRA is its untaxed growth.

Over time, the tax you pay for the Roth conversion could effectively diminish as your assets grow, as it gets distributed across a larger sum.

Furthermore, Roth conversions can be instrumental in supporting your legacy plan. Under the SECURE Act 2.0, most IRA beneficiaries are required to withdraw funds within 10 years.

If the original IRA owner was taking RMDs, the inheritor must also adhere to RMDs during this window. This poses a challenge for many legacy plans, especially those of affluent families.

However, through a Roth conversion, you can pay taxes at the current rates, which may be lower for many taxpayers. As a result, your heirs might not face any taxation.2

Open a Spousal IRA

In households where only one spouse generates income, you can potentially boost contributions and reduce current taxes by establishing a new IRA account for the non-working spouse. To illustrate, let’s consider a hypothetical example derived from an IRS publication:

Imagine John is a full-time student with no taxable income, while his wife, Shelby, earns an annual taxable income of $80,000. Shelby is currently contributing $6,000 per year to an IRA, which is their contribution limit as they’re under 50 years old. To enhance their contributions, she opened an additional IRA under John’s name.

When they file jointly, John can add Shelby’s annual income minus her contribution ($80,000 – $6,000 = $74,000) to his compensation (which is $0 in this case) to determine his maximum contribution amount. As their combined compensation is $74,000, his individual IRA contribution limit also amounts to $6,000.

This means they can effectively double their IRA contribution. If they’re comfortable foregoing the tax deduction, they can both opt for Roth IRAs instead.

“We come across numerous instances where clients overlook this opportunity. If it reduces your taxes, why not seize it?” emphasizes Tom Hussian, Advice Services consultant at Thrivent.

Examine the Potential of Municipal Tax-Exempt Bonds

Aside from offering inherent federal tax advantages, tax-exempt municipal bonds can also provide state-level tax benefits in certain scenarios.

When you invest in municipal bonds issued within your state, you frequently bypass state and local taxes.3 Furthermore, if you reside in a state with no income tax, you can enjoy tax-free income by incorporating this supplementary investment.

To determine your eligibility for specific benefits, you must carefully review your local tax laws, as the tax advantages of municipal bonds depend on your income and place of residence.

To illustrate, affluent households residing in high-tax states typically reap substantial rewards from municipal bond investments.

Conversely, individuals with lower incomes who dwell in states with no or low income tax may not experience the same level of tax advantages.

Leverage Permanent Life Insurance as an Asset

While the primary intent of life insurance is to secure your loved one’s future, a well-suited policy can also serve as a means to manage taxes. Unlike other sources of retirement funds, beneficiaries of life insurance death benefit payouts receive them free from income tax implications.4

Permanent life insurance varieties like whole life, universal life, and variable universal life are crafted to provide lifelong coverage, as long as the policy remains active.

Moreover, these policies may accumulate cash value on a tax-deferred basis over your lifetime. Tax-deferral bolsters the rapid growth of your cash value, as its expansion remains unaffected by yearly taxation.

Should the need arise for you to access these funds prematurely, you can tap into the cash value on a tax-advantaged basis, ensuring tax-free access up to the sum you’ve contributed via premiums or a policy loan.

Nonetheless, it’s recommended to consult with a financial advisor or tax expert before accessing these funds ahead of schedule, to prevent any unnecessary tax repercussions.

Additionally, your policy contract (like whole life) may qualify for dividends, which are yearly distributions from your insurance company allocated based on your contributions to the company’s surplus. Keep in mind that dividends are never guaranteed.

Strategies for Making the Most Out of Tax-Efficient Charitable Giving

Investigate in-depth methods for maximizing charitable donations that are tax-efficient in order to have a significant effect on both your finances and the issues you care about. These strategies not only help causes that are dear to your heart, but they may also have tax advantages.

By using these strategies, you not only improve your general financial situation but also give back to your community. By combining your charitable objectives with astute financial planning, these tax-efficient giving strategies make sure that your donation creates a lasting good impact while also maximizing your tax status.

Donor-Advised Funds (DAFs)

A DAF is a philanthropic vehicle that allows you to make a charitable contribution, receive an immediate tax deduction, and then recommend grants to your favorite charities over time. By contributing appreciated assets like stocks or mutual funds, you can potentially avoid capital gains taxes.

Qualified Charitable Distributions (QCDs)

If you’re 70½ or older and have an individual retirement account (IRA), you can make tax-free distributions directly to eligible charities. These QCDs count towards your required minimum distribution (RMD) and can reduce your taxable income.

Charitable Remainder Trusts (CRTs)

Establishing a CRT allows you to donate assets to a trust, receive an income stream for a specified period, and then have the remaining assets distributed to the charity of your choice. In addition to giving you the chance to assist charitable causes, this may allow you to claim potential income tax deductions.

Key Takeaways: Important Things to Consider

Here are the things you have to think about when it comes to investing for retirees:

Understanding Retirement Account Tax Implications

Retirement planning is greatly aided by the use of retirement funds like 401(k)s and Roth IRAs. Understanding how they affect your taxes is essential. While traditional IRA withdrawals and Social Security benefits may incur federal income tax, Roth IRAs offer tax-free withdrawals. Managing these accounts wisely can impact your overall tax exposure.

Balancing Tax-Free Withdrawals and Minimizing Burden

Achieving a harmonious balance between tax-free withdrawals and taxable income sources is essential. Utilizing Roth IRAs for tax-free income and optimizing distributions from other tax-advantaged accounts can minimize your tax burden. This approach ensures that your retirement income is maximized while minimizing your liability.

Strategic Approaches to Capital Gains and Charitable Giving

Managing capital gains taxes on investments is crucial. Applying strategies like tax-efficient asset allocation and timing capital gains realization can reduce your tax liability.

Utilizing post-tax funds for charitable gifts can also result in possible tax deductions and help you achieve your philanthropic objectives, improving both your financial and charitable outcomes.

Dividends Stocks

Receiving qualifying dividends, which are essentially normal dividends from publicly traded U.S. companies as well as some overseas companies, will result in lower taxes than doing so with ordinary income. Depending on your taxable income, the tax rate could be zero, 15%, or 20%.

Retirees can increase their financial stability, make the most of their retirement income, and guarantee a successful retirement journey by carefully navigating the complexities of tax techniques.

Final Thoughts

In conclusion, retirees have access to a wide range of effective tax strategies that can help them enhance their financial security while navigating the complexities of taxation.

By employing these strategies, retirees may be able to minimize their tax obligations and increase their retirement savings. Roth IRAs and tax-exempt municipal bonds are just two examples of tax-efficient retirement planning techniques that retirees might adopt.

Qualified Charitable Distributions (QCDs) and Donor-Advised Funds (DAFs) offer opportunities for charitable giving while possibly reducing taxable income.

Exploring options like Charitable Remainder Trusts (CRTs) and Charitable Gift Annuities (CGAs) allows retirees to support charitable causes while managing their finances effectively. Bunching charitable contributions and utilizing the Charitable IRA Rollover are valuable strategies to consider as well.

A permanent life insurance policy can also be kept as an asset by retirees, which can help them save money on taxes by offering income tax-free death benefits and tax-deferred growth in addition to protecting loved ones.

Every retiree has a unique financial situation, so it’s critical to work closely with financial advisors and tax professionals to tailor these techniques to fit particular requirements and objectives. By staying informed of the constantly changing tax landscape and making wise decisions, retirees can maximize the available tax benefits and enjoy a more financially secure and enjoyable retirement.