Everyone can benefit by minimizing their tax liability, but retirees in particular have to pay close attention to their tax bills. When you're on a fixed income, you can't afford to pay the IRS any more than is absolutely necessary. Fortunately, there are ways that you can minimize your taxes in retirement and enjoy your golden years in style. The following tips will give you a good starting point for considering how to cut your tax bill.
1. Have a mix of retirement accounts
Many retirees have much higher tax bills than they expect because of withdrawals they make from retirement accounts. Traditional IRAs, 401(k)s, and other tax-favored retirement plan accounts require you to include any withdrawals as taxable income in the year in which you take money out of your retirement account. If you have Roth IRA or Roth 401(k) accounts, you typically don't have to pay income on withdrawn funds. By planning for retirement with a mix of regular and Roth retirement accounts, you can balance your withdrawals to help you with your tax planning, drawing money from each source in a way that cuts your taxes to the largest extent possible.
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2. Keep taxes on Social Security under control
Under certain circumstances, Social Security benefits become taxable. Specifically, if the sum of your outside income and one-half of your Social Security adds up to more than $25,000 for singles or $32,000 for couples, then a portion of your benefits can be subject to tax. If you can keep your outside income lower for tax purposes, then it can have the added benefit of leaving your Social Security untaxed as well.
3. Take full advantage of low rates on dividends and long-term capital gains
Qualified dividends and long-term capital gains get taxed at lower tax rates, and smart investors take full advantage of those breaks even in retirement. In particular, if you're in the 10% or 15% tax brackets for ordinary income purposes, then you get tax-free treatment on dividends and capital gains. By being mindful of when you sell your investments and whether the dividends that a particular stock pays are qualified or not, the net result can be bigger tax savings than you would expect.
4. Don't forget tax breaks for seniors
A number of favorable tax provisions apply to retirees. For example, the standard deduction for those who are 65 or older rises by $1,550 for singles or $1,250 for joint filers from the regular figures for those younger than 65. Other tax perks apply to seniors, so make sure you take full advantage.
5. Be smart in picking a place to live
If you're looking to relocate in retirement, being tax-savvy can save you a lot of money. Some states don't impose income taxes at all, while others have low income tax levies combined with reasonable rates for other types of taxes like sales tax and property tax. Taxes shouldn't drive your entire living decision in your golden years, but it's worth taking into account if you're already considering a move away from your current home.
6. Make charitable gifts in a tax-favorable way
Many older Americans have investments that have jumped in value over the years. Using appreciated stock to make charitable gifts is a great way to avoid taxes on capital gains, and it can take away the need to sell shares in order to raise enough cash to make conventional donations to charity. Other strategies like using tax-free contributions from an IRA to make gifts to charity can often have positive tax ramifications.
7. Don't forget estate tax
Finally, keep in mind that the estate tax still exists, and the 40% tax rate that applies to taxable estates exceeds every single tax bracket in the income tax system. Estate tax planning can be complicated, but it can pay off with huge savings for your loved ones. By being mindful of estate tax and structuring your gifts and bequests in a way that reduces the amount of potential tax your estate will owe, you'll be best able to plan for all of your tax liability and keep as much of your money as possible out of the hands of tax collectors.
Don't pay more tax than you have to
By following these tips, you can minimize the amount of tax you pay in retirement. That will leave you the largest amount possible to spend toward making your retired years the most memorable time of your life.
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