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3 Ways to Legally Get Out of Paying Taxes in Retirement

By Maurie Backman – Apr 21, 2019 at 6:18AM

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Seniors need all the money they can get. Here's how to keep more of yours away from the IRS.

Let's face it: Taxes are a drag at any time in life. But in retirement, they can constitute a major strain on your limited financial resources. As such, it pays to find ways to lower your tax burden as a senior, and here are three ways to do it.

1. Save in a Roth IRA or Roth 401(k)

IRAs and 401(k)s come in two main varieties: traditional and Roth. With the former, contributions go in tax-free, and workers get an immediate tax break for funding their accounts. Withdrawals in retirement, however, are taxable.

Roth accounts work the opposite way: Contributions are made with after-tax dollars, so there's no immediate benefit to funding an account. Withdrawals, on the other hand, are taken tax-free in retirement, thereby lowering your taxes at a time in life when you could really use that flexibility.

Older man with gray hair leaning against a tree

Image source: Getty Images.

If your company offers a 401(k) plan with a Roth savings feature, you can sign up regardless of how much you earn. Roth IRAs, by contrast, prohibit higher earners from making direct contributions, but if your income is too high to fund a Roth IRA directly, you can instead put money into a traditional IRA and then convert it to a Roth after the fact.

2. Invest in municipal bonds

Seniors are generally advised to shift toward more conservative investments as they age, which generally means choosing bonds over stocks (though it's still a good idea to hang on to some stocks during retirement). If you're going to load up on bonds, then choosing municipal bonds over corporate bonds is a good way to keep your taxes to a minimum. That's because the interest you collect from municipal bonds is always exempt from federal taxes, and if you buy municipal bonds issued by your home state, you'll avoid state and local taxes as well. Corporate bond interest, on the other hand, is always taxable.

3. Hold investments for at least a year and a day

Whenever you sell an investment at a price that's higher than what you paid for it, you're liable for capital gains taxes. But the amount of time you hold that investment before unloading it could dictate how much tax you pay for selling it at a profit.

Investments held for a year or less fall into the short-term capital gains category, and the taxes you'll pay on short-term gains mimic those you'll pay on your ordinary income. On the other hand, if you hold your investments for at least a year and a day, you'll be propelled into the long-term capital gains category, and you'll benefit from the lower tax rates associated with it.

Though long-term capital gains tax rates can change from year to year, in 2019, you'll pay nothing if you earn less than $39,375 as a single tax filer. And if your income is above $39,375 but less than $434,550, you'll pay just 15% on long-term capital gains, which is far less than what you'd pay in income taxes for earnings at the high end of that range.

The less tax you're liable for in retirement, the more money you'll have to pay your bills and enjoy your life. Therefore, think about the ways you might reduce your tax burden as a senior well before that milestone arrives, so that once it does, you're well positioned to keep more of your income away from the IRS.

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