Lowering Your Tax Bill in Retirement

Cheri Franklin |

Upon retirement, many people are unpleasantly surprised by how high their taxes are. From required minimum distributions in traditional IRAs and retirement plan accounts to the partial taxability of Social Security benefits to Medicare Part B premiums, Uncle Sam will always get his due. So here are a few suggestions for lowering your tax bill in retirement.

If you are currently working, a Roth 401(k) may be preferable to a traditional 401(k). While you would forego the benefit of the immediate tax deduction, it can save you money down the road, especially if you are in a higher tax bracket in retirement. Not only are distributions from a Roth account tax-free, there are no required minimum distributions (RMDs) until the death of the owner. You may also be able to do an in-plan conversion of your traditional 401(k) to a Roth 401(k), but this would only make sense if you have cash necessary to pay the taxes on the conversion (and you expect your tax rate to increase or at least not decline). The same holds true for converting a traditional IRA to a Roth IRA. Lastly, conversion does not have to be an all-or-none proposition. It may be prudent to do a partial conversion, possibly up to your tax bracket’s upper limit. The guidance of a competent tax professional is crucial in these situations.

Another way to reduce your RMDs is to donate IRA savings to charity. The IRS allows taxpayers to donate up to $100,000 annually from their traditional IRAs, as long as the money is sent directly from the IRA trustee to the charity. While such donations can reduce your RMDs, they do not qualify for the charitable deduction. Strategic gifting could also reduce estate taxes for individuals and couples with estates larger than $5.45 and $10.9 million, respectively as of 2016.

Finally, if you currently reside in a high-tax state (California comes to mind), you may want to consider moving to a low-tax state. However, please note that a low or zero income tax can be compensated by a high sales or property tax, not to mention homeowner’s insurance costs, especially in coastal areas.