5 Strategies for Saving Taxes in Retirement
By Andrew J. Tapparo, MSF, RICP®
When you think about retirement, I bet the word “taxes” doesn’t come to mind. Most people only think about taxes once a year (when that filing deadline looms), and then they put it out of their mind until the next year. While this might work—for the most part—when you are in your working years and building up your accounts, this doesn’t work for retirement when your income has significantly changed.
It’s important to have a plan before you retire so you aren’t left short-handed. Minimizing your tax liability as much as possible should be a big part of that plan. Here are 5 ways you can save on taxes in retirement.
1. Limit Your Exposure to the 3.8% Medicare Surcharge Tax
There is a 3.8% Medicare surcharge tax that applies to net investment income for singles with a modified adjusted gross income (MAGI) of over $200,000 and couples with a MAGI of over $250,000. The MAGI is adjusted gross income with some deductions added back in, such as tax-free foreign income, IRA contributions, and student loan interest. The surcharge tax is due on the smaller net investment income (which includes interest, dividends, annuities, gains, passive income, and royalties) or the excess of MAGI over the thresholds.
If your MAGI is near or above the thresholds, there are steps you can take to limit your exposure. First, you will want to review the tax efficiency of your investment holdings. It may be worthwhile to move less efficient investments into tax-deferred accounts and capitalize on tax-loss harvesting. Other moves you can make include investing in municipal bonds, which have tax-free interest, and taking capital losses to offset gains. Installment sales can spread out large gains and minimize your adjusted gross income, and real estate-like-kind exchanges can also defer gains and their taxability.
2. Utilize Roth IRA Conversions
Distributions from Roth IRAs are tax-free, so they are a great tool to have in retirement. However, some people cannot contribute directly to a Roth IRA because of income limitations. Instead, you have to convert traditional IRA funds to a Roth account by paying the related income taxes. You can take advantage of low-income years, such as when you have stopped working but are not yet collecting Social Security, to convert your funds to a Roth IRA so you’ll have tax-free income later. It is important to be mindful of tax brackets when you do conversions, so you don’t inadvertently push yourself into higher tax rates.
3. Take Advantage of the 0% Rate on Long-Term Capital Gains
If the Medicare surcharge tax is irrelevant to you because your income is lower, then you may be able to take advantage of the 0% long-term capital gains rate. Profits on the sales of assets owned over a year are tax-free if your income is below $47,025 for singles or $94,050 for married couples filing jointly. Once you exceed those thresholds, long-term capital gains are taxed at 15% until your income gets above $518,900 for singles or $583,750 for couples, at which point the tax rate goes up to 20%.
Claiming more deductions or making deductible IRA contributions can help keep your income within the 0% capital gains tax range while also providing their usual tax benefits. However, you will want to be strategic about taking tax-free gains as they can raise your adjusted gross income and affect the taxability of your Social Security benefits. Also, taking those gains may incur state tax liabilities as well.
4. Be Strategic About Inherited IRAs
At the beginning of the year, the laws surrounding IRAs inherited by non-spouses changed. In most cases, you no longer have to take out a specific amount of money from the account each year, but you are required to empty the account within 10 years. If you fail to be strategic about withdrawals, you could be forced to empty the entire account at once with 10 years’ worth of growth. The problem with that is that it would greatly increase your taxable income for the year, possibly pushing you into a higher tax bracket and subjecting you to added taxes, like the Medicare surcharge tax. If you inherit an IRA from someone other than your spouse, you need to be strategic about your withdrawals and time them to limit your tax liability.
5. Donate Effectively
If you are charitably inclined, one of the best ways to save on taxes is through donations. You can get a tax deduction on donations up to 60% of your adjusted gross income. If you have appreciated assets, you can get an even greater tax break. When you donate an appreciated asset that you have owned for over a year, such as stocks, to a charity, you do not have to pay capital gains taxes on the appreciation, but you still get to claim the full value for your deduction. This allows you to avoid the capital gains tax altogether. If your assets have declined in value, it is best to sell them yourself and donate the proceeds so you can claim the loss when filing your taxes.
Another strategy to consider is the use of a charitable lead annuity trust or a donor-advised fund, which allows you to take an up-front write-off that can help offset other income, such as from a Roth IRA conversion or withdrawal from an inherited IRA.
If you are over the age of 70 ½, a Qualified Charitable Distribution (QCD) is another powerful tax-saving tool for the charitably inclined. A QCD allows you to donate up to $105,000 in 2024 directly to one or more charities from your Traditional IRA. You will not receive a tax deduction for this charitable contribution, but the amount of the QCD will not be included in your taxable income.
QCDs really shine when you are subject to Required Minimum Distributions (RMD), as they can be utilized to satisfy your RMD. Timing is everything here. If you want to decrease the amount of your RMD that is included in your taxable income, it is important to take your QCD before you take your RMD. This is because the first dollars out of your IRA go towards satisfying your RMD.
How We Can Help
While you can’t eliminate your tax burden, there are steps you can take to minimize it during retirement. Of course, there are many variables to making this work and each person’s situation is unique—which is why it’s important to work with a trusted financial advisor or tax professional. Understanding all the steps in the process may seem overwhelming, but you don’t have to walk through this process alone. An experienced financial advisor can help you navigate all the details so you can have confidence in your retirement plan.
If you don’t already have a financial partner in your corner, I would love to have a conversation with you. The Tapparo Capital Management team specializes in tax-efficient retirement planning and can help you take the first step toward your ideal retirement. Schedule a “Get Acquainted Call” to see if we are a good fit for each other by calling 978-887-1121 or emailing us at andrew@tapparocapital.com to get started today.
About Andy
Andrew Tapparo is a fee-only financial advisor at Tapparo Capital Management, a financial planning firm in Topsfield, MA, helping clients turn their savings into a retirement income that lasts. Inspired by the quote “Choose a job you love, and you will never work a day in your life,” Andy founded Tapparo Capital Management in 1997 with a passion for helping clients enjoy a truly worry-free and fulfilling retirement and experience financial freedom. As a Retirement Income Certified Professional (RICP®), he designs retirement strategies along with sound money management to help clients retire with confidence.
Andy holds a Bachelor of Science in Industrial Engineering from Rochester Institute of Technology in Rochester, New York, and a Master of Science in Finance from Bentley University in Waltham, Massachusetts. Specializing in retirement income planning, Andy completed a comprehensive financial industry education program at The American College of Financial Services and was awarded the Retirement Income Certified Professional® designation. He is frequently quoted in the media as a financial expert.
Andy and his wife, Susan, live in Topsfield, Massachusetts, and have two beautiful daughters. Outside of work, he is an automobile enthusiast, enjoys taking road trips, and loves the Outer Banks of North Carolina. In his spare time, he volunteers with the local high school varsity girl’s basketball team as the team statistician and runs the team’s website. He is passionate about supporting charities that serve our veterans and their families. To learn more about Andy, connect with him on LinkedIn.