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Want to Lower Your Taxes in Retirement? Do This 1 Thing.

By Maurie Backman – Sep 9, 2020 at 7:49AM

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Here's how to keep the IRS away from your money during your senior years.

Seniors are often shocked to learn that much of their income is subject to taxes. Social Security benefits, for example, are generally taxable when they're not the sole source of income in play, and retirement plan withdrawals are taxable when they come from a traditional IRA or 401(k). But if your goal is to lower your tax burden once you're no longer part of the workforce, the answer could boil down to choosing the right retirement plan to save in.

The benefit of housing your savings in a Roth IRA

While there are a number of dedicated retirement savings plans you can choose from during your working years, it pays to favor a Roth IRA for a couple of reasons. First, investment gains in Roth IRAs are yours to enjoy tax-free, and withdrawals in retirement are tax-free as well, which means the IRS can't touch that income source.

Older man at laptop

Image source: Getty Images.

Now you may be thinking: What about a Roth 401(k)? Roth 401(k)s offer similar benefits to Roth IRAs -- tax-free investment gains and withdrawals -- and they also come with a higher annual contribution limit. But here's where Roth IRAs and 401(k)s differ: With the former, you don't have to take yearly required minimum distributions (RMDs). With the latter, RMDs still apply during retirement, which means you can't leave your savings intact as long.

Do you qualify for a Roth IRA?

If there's one negative feature of the Roth IRA, it's that higher earners are barred from contributing to one directly. The income limits that apply to Roth IRAs change from year to year, but in 2020, you can't contribute once your adjusted gross income exceeds $139,000 as a single tax filer, or $206,000 as a married couple filing jointly. If your filing status is head of household, that $139,000 limit applies to you, too. And if you're married filing separately, the income limit is just $10,000.

If your earnings exceed these limits, however, you're not out of luck. That's because you'll still have the option to open what's known as a backdoor IRA, which really means funding a traditional IRA and converting that account to a Roth after the fact. Now there will be tax implications involved -- namely, you'll need to pay taxes on any amount you roll over. But that way, you're paying those taxes while you're working, as opposed to having to pay them once you're retired.

Ease the burden

Many seniors worry about managing their money in retirement. After all, the loss of an incoming paycheck from work can be stressful.

If you want to minimize one financial concern during your senior years -- taxes -- then it pays to put your savings into a Roth IRA. Doing so will give you a lot more flexibility with your money later in life, all the while keeping those funds out of the IRS' reach. Plus, with a Roth IRA, your withdrawals won't count toward calculating your provisional income, which determines whether your Social Security benefits will be taxed or not. And that's a perk that's hard to beat.

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