Even after spending a lifetime paying taxes, you likely won't be able to escape them in retirement. It's crucial to account for taxes as you're planning for your senior years -- otherwise you risk not saving as much as you need.
However, there are a few ways to reduce how much you pay in taxes during retirement that can help your savings go further.
1. Invest in a Roth IRA
A Roth IRA is one of the most effective tools to slash your taxes in retirement. When you invest in a Roth IRA, you'll pay taxes on your initial contributions, but your withdrawals in retirement are tax-free. So if the majority of your savings are invested in a Roth IRA, you may be able to largely avoid taxes in retirement.
There are a couple of downsides to Roth IRAs, though, including the fact that high earners may not be eligible to contribute directly to this type of account (though there are other options if your income exceeds the annual limit). In addition, Roth IRAs have a much lower annual contribution limit than 401(k)s -- just $6,000 per year for Roth IRAs, compared to $19,500 per year for 401(k)s -- which can be a drawback if you're a super saver. However, if your primary goal is to reduce your taxes in retirement, a Roth IRA is one of your best options.
2. Consider moving to a more tax-friendly state
If any of your savings are invested in a 401(k) or traditional IRA, your withdrawals could be subject to income taxes. But just how much you owe -- and whether you'll owe income taxes at all -- will depend largely on what state you call home.
There are currently seven states -- Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming -- that do not have state income taxes. In addition, Tennessee and New Hampshire are currently phasing out their state income taxes, and planning to eliminate their taxes by 2021 and 2024, respectively.
If you're considering moving, be sure you've thought about the big picture. You may save some money on taxes by moving to a more tax-friendly state, for example, but if the average cost of living is significantly higher, you may be spending more overall.
3. Take advantage of an HSA
A health savings account (HSA) is like a retirement account just for healthcare costs. And the biggest advantage of an HSA is the triple tax benefit.
When you invest in an HSA, your initial contributions are tax-deductible. Your savings then grow tax-deferred, and your withdrawals are also tax-free as long as the money goes toward qualifying medical expenses.
The drawback to an HSA is that you have to be enrolled in a high-deductible healthcare plan to be eligible for one, and there are also contribution limits each year. But if you qualify for this type of account, it can potentially save you money in retirement.
4. Be strategic about your retirement account withdrawals
Saving for retirement is only half the battle; you also need to plan for how you'll withdraw your cash. If you have money stashed in both tax-deferred and tax-free accounts, it's wise to have a strategy for how much you'll withdraw from each account each year.
For example, during years when you know you'll be spending more, you may opt to pull more money from your Roth IRA to avoid pushing yourself into a higher tax bracket. Then during years where you're spending less, you can tap your 401(k) or traditional IRA. By withdrawing strategically, you can avoid spending more than you have to in taxes.
Taxes may be unavoidable for many people, but that doesn't mean you can't limit them as much as possible. By being strategic about how you plan for retirement, you can minimize your taxes and keep more of your hard-earned savings.