When you leave the workforce and give up a paycheck, life seems grand -- endless free time, no more alarm clocks, and lower tax rates -- or so it seems at first. Even if you're raking in over a million dollars in retirement savings a year, you won't have to pay and , and some states don't tax such income either.
Planning your income in retirement -- and reducing your overall tax bill -- is critical to making your last. Here are eight ways to manage your tax bite after you leave the workforce.
1. Strategically withdraw from your tax bracket (which starts at $36,250 for singles and $72,500 for married filing jointly in 2013), says William Reichenstein, chair at Baylor University.. Rules on tax-deferred retirement plans like IRAs, 401(k)s, and 403(b)s allow you to take distributions starting at age 59.5, and you must start withdrawing the by age 70.5 or face stiff penalty fees. It's usually better to pull out when your for the year be lower, especially when the total stays under the 25-percent
Being strategic means you'll pay the 10- or 15-percent rate on those withdrawals. You might take out tax-deferred lot of deductions -- when you're paying high medical expenses, for example, or are making a large charitable contribution, which would significantly reduce your taxable income. For example, you might have one year when your income from a pension is $40,000, but you have medical expenses of $20,000; this would be an excellent time to withdraw from an IRA. If you know you'll exceed $36,250 (or $72,500 for married couples), it's best to stay under the next tax bracket., for example, in a year when you have a
2. Pay estimated Social Security income is taxable, depending on the amount of your “combined income,” which the government defines as your adjusted gross income, plus any non-taxable interest (interest earned on tax-free municipal , for example), plus 50 percent of your Social Security benefits. For an individual, if your combined income is between $25,000 and $34,000, you'll pay normal income tax rates on up to 50 percent of your benefits; if it's more than $34,000, you'll pay tax on up to 85 percent.on your benefits.
Mark Steber, chief tax officer at Jackson Hewitt Tax Service, says you can request that the Social Security Administration withhold those taxes from your checks, but it's better to make estimated payments yourself because it's common for combined income to fluctuate a , and the amount withheld would likely be too high or low.
3. Consider delaying your Social Security checks. One benefit of waiting to collect Social Security until you're older is that your checksbe larger. Though you can start collecting any time between the ages of 62 and 70, for every year you wait, your check grow by roughly 6.25 percent, says Philadelphia-area Daniel White of Daniel White & Associates. But taxes also play into it.
In a paper last April for the Journal of Financial Planning, Baylor's Reichenstein and a coauthor tested the effects of starting Social Security at different ages. They found that someone who retired in 2011 at age 62 with $700,000 in savings and started taking monthly Social Security checks of $1,125 that year would exhaust their portfolio in 30 years at a given spending level. But if they used their own assets to their early retirement and started taking their now-much-larger checks of $1,980 at age 70, their portfolio would last at least 40 years at that same spending level. This is in part because only 50 percent of your Social Security benefits count toward the combined-income threshold. Of course, all decisions like this are a gamble -- if you die young, it would have been better to start taking Social Security earlier. However, if you have a surviving spouse, he or she would receive all or part of your benefit, depending on their age.
4. Give your children appreciated assets instead of stock that's grown since you bought it, says White. Of course, your family member pay the when they sell the , so for both of you to benefit, the recipient should be in a lower tax bracket than you are -- which is likely if you're helping them out.. If you're planning to give to the children or grandchildren, one way to do so while getting a is instead of , give them a
5. Convert your IRA to a Roth IRA, says Matthew Curfman, certified at Richmond Brothers in Jackson, Michigan. Growing your in a Roth and then being able to withdraw it tax free protect you against future tax increases. Also, since there's no mandatory withdrawal on a Roth, it makes an excellent long-term contingency -- and any withdrawals don't count in the combined-income formula used to tax Social Security benefits, David Littell, co-director of the American College of Financial Services' Center for Retirement Income.. If you can afford to pay the taxes, start converting your IRA to a
6. Make charitable contributions from your IRA. The New Year's Day fiscal cliff deal resuscitated an expired provision for 2013 that allows people age 70.5 or older to donate up to $100,000 from their IRA to a qualified charity, without having to pay taxes on the transfer. That donation can help satisfy your required minimal distribution. You can't beat that provision, Curfman says. If you donate $20,000 from your IRA to the charity, the nonprofit gets all of it. But if you withdraw $20,000 out of your IRA and then donate the -- so if the tax was $3,000, the charity gets only $17,000., the taxes it before you make the donation
7. Raise the capital rate is zero (yes, zero) on people whose income them in the 15-percent bracket or lower (up to $36,250 for a single filer and $72,500 for married filing jointly).of your when your income is lower. Low-income years in retirement are a great time to sell a stock that has appreciated and reinvest the in stock of a similar class, says Reichenstein. That's because, under the fiscal cliff deal, the long-term
In years when you're in one of those brackets, you can sell a stock you bought originally at $40,000 that's now worth $50,000 and buy another stock worth $50,000. You've raised the cost basis of the stock by $10,000, reducing the taxes you'll pay if you have to sell it in a year when you're in the 25-percent or higher bracket. Use caution though, says Reichenstein: Make sure that $10,000 in doesn't push your income for the year high enough that it would cause your combined income to rise to the point that your Social Security benefits are taxed at a higher rate.
8. Move to a tax-friendly state. If you're moving for retirement, consider taxes as part of your decision, says Diana Webb, assistant professor of finance at Northwood University. A report last September from Kiplinger identified Alaska, Nevada, and Wyoming as the three states with the most retirement-friendly tax laws. The worst include Ohio, California and New York.
Steve Yoder writes for The Fiscal Times. This article originally appeared as: 8 Smart Ways to Lower Your Taxes in Retirement.
Check out these other articles from The Fiscal Times: