Rosalind Evans
Are you concerned about the taxes you’ll face during your retirement? Explore practical ways to reduce your tax liability in retirement, including managing Required Minimum Distributions (RMDs).
The United States government’s spending problem is no secret, with the national debt reaching a staggering $31.5 trillion and steadily growing. Eventually, the bill will come due, potentially resulting in significant tax increases. Moreover, the 2017 tax cuts are set to expire by the end of 2025, signalling another impending tax change.
These looming tax uncertainties can be especially worrisome for retirees, who are already focused on ensuring their savings last a lifetime. Fortunately, options are available to help minimize your tax burden in retirement. Consider the following strategies:
Roth Conversions:
Converting your traditional IRA and 401(k) accounts to Roth accounts has become a popular method for reducing taxes in retirement. Many Americans have retirement savings in tax-deferred accounts like traditional IRAs or 401(k)s, where contributions are made pre-tax. However, when retirees start making withdrawals, taxes become due.
Additionally, individuals aged 73 and above are subject to Required Minimum Distributions (RMDs), which mandate withdrawing a specific percentage each year and paying taxes on the amount withdrawn, regardless of whether it’s needed. Roth IRAs, on the other hand, don’t have RMDs since contributions are made with after-tax money. With Roth conversions, you pay taxes upfront but enjoy tax-free growth and no RMD concerns.
To optimize this strategy, ensure you execute it wisely. Shifting all your funds at once might push you into a higher tax bracket, resulting in a hefty tax bill. It’s advisable to spread the conversions over several years, considering factors like Medicare premiums. Consult a financial professional to determine the best approach for your situation.
Qualified Charitable Distributions (QCDs):
QCDs offer a way to avoid RMDs, which is particularly beneficial for those who don’t require their IRA funds and wish to support their favourite charities. Setting up a QCD allows you to directly transfer your withdrawal to the charity without incurring taxes.
Arranging a direct transfer from your IRA to the QCD is crucial to ensure tax-exempt status. The withdrawal remains taxable if the funds pass through your hands before the contribution. Key considerations include being 70½ or older, eligibility for IRAs (not 401(k)s), and the maximum annual contribution limit of $100,000 per individual.
Donor-Advised Fund:
Given the increased standard deduction on Form 1040, many people no longer itemize deductions, reducing the tax advantages of charitable donations. However, a donor-advised fund can be a helpful tool in some cases.
A donor-advised fund allows you to deposit donations for future distribution to your chosen charity. You receive an immediate tax deduction, and the funds can grow with interest over time before being disbursed. This approach can help surpass the standard deduction. For instance, consolidating three years’ worth of $10,000 annual donations into a donor-advised fund allows you to claim a tax deduction while the charity receives payments over time.
Adjusted RMD Age:
The age for commencing RMDs has changed. Previously 72, it now stands at 73, and from January 1, 2033, it will further increase to 75. Although delaying RMDs might sound appealing, it carries certain risks. RMDs are calculated based on the account balance, and delaying them may result in a larger balance, thereby increasing the RMD amount and tax liability. This underscores the importance of considering a Roth conversion.
It’s crucial to remember that taxes should be a year-round consideration, not just a last-minute concern during tax season. Dec. 31 is the tax deadline, as it offers opportunities to make strategic financial moves to minimize your tax bill. While CPAs excel at tax preparation and ensuring compliance, they may need to gain expertise in tax planning. Hence, it’s beneficial to assemble a tax team comprising a CPA and a knowledgeable financial professional who can navigate the tax landscape and help you optimize your financial position.
By proactively implementing these tax-reducing strategies, you can take control of your retirement tax liability and secure a brighter financial future. With careful planning, including Roth conversions, qualified charitable distributions, donor-advised funds, and staying informed about adjusted RMD ages, you can navigate the complex tax landscape and pay only what is required. Remember, it’s always early enough to start strategizing and collaborating with professionals who can help you make informed decisions to minimize your tax burden. Don’t let taxes overshadow your retirement dreams—empower yourself with knowledge and take the necessary steps to keep your hard-earned money where it belongs: in your pocket.
