Working folks would do just about anything to avoid paying taxes, and seniors, too, are eager to ease that burden. In fact, in some ways, it's even more important to be tax-savvy when you're older because at that stage of life, you may be limited to a fixed income that gives you less financial flexibility.
The good news? Some smart planning on your part could help you avoid a huge tax bill in retirement. Here are a few strategies to consider to achieve that goal.
IMAGE SOURCE: GETTY IMAGES.
1. House your savings in a Roth IRA or 401(k)
You need independent savings to help pay the bills in retirement, but the account you choose could make a world of difference from a tax perspective. Traditional IRAs and 401(k)s offer tax breaks on contributions, but withdrawals are considered taxable income.
Roth IRAs and 401(k)s, on the other hand, don't offer an immediate tax break on contributions but allow for tax-free withdrawals. If you keep your retirement savings in a Roth account, that money is yours to access free and clear of the IRS when you're older.
2. Invest in municipal bonds
Bonds are often regarded as a suitable investment for seniors. They're not only fairly stable, but they're a good source of predictable income since they pay interest twice a year
If you buy corporate bonds -- those issued by public companies -- you'll pay taxes on your interest income. But if you buy municipal bonds -- those issued by cities, states, and other public entities -- you'll avoid federal taxes on the interest payments you collect. And if you purchase municipal bonds that are issued by your state of residence, you also won't be subject to state or local taxes on that interest.
3. Fund a health savings account
Healthcare is usually one of the largest expenses seniors face. Now you can save for future healthcare costs by padding your regular savings account or boosting your IRA or 401(k). But if you're eligible to participate in a health savings account, you can sock away funds for medical costs in the most tax-advantaged manner possible.
To qualify for an HSA, you must be enrolled in a high-deductible health insurance plan, the definition of which changes from year to year. If you are eligible, the money you put into your HSA goes in tax-free. From there, you can withdraw funds to pay for near-term medical expenses or carry unused funds forward, such as into retirement, and use them later.
Any money you don't withdraw immediately can be invested, and gains in that account are yours to enjoy tax-free. And when you're ready to take HSA withdrawals, those are also tax-free, as long as they're used to pay for qualified medical expenses.
4. Move to a state with no income tax
Though there are a host of valuable credits and deductions that can help you lower your federal income tax burden, you may still need to deal with taxes at the state level. But if you retire in a state that doesn't impose income taxes, you'll avoid that hassle entirely.
There are seven states that don't have an income tax:
- Alaska
- Florida
- Nevada
- South Dakota
- Texas
- Washington
- Wyoming
As a senior, you might not find the cold climates of Alaska, South Dakota, and Wyoming appealing. But there's a reason why Florida is such a popular choice for retirees, and it's not just the weather -- it's the potential tax savings, as well.
The less tax you pay in retirement, the more money you'll have left over to cover your bills and enjoy life. Employ these and other tactics to avoid taxes in retirement, because after a lifetime of paying them, you finally deserve a break.
