Retirement means ending your journey in the working world and setting yourself free from all the burdens that come with a busy career. No more meetings or work projects. No more planning your schedule around work commitments. And no more basing your vacations around your paid-time off.

What about taxes? If you’re not working and earning income, you won’t be paying taxes, right?

Not exactly.

Even after you stop working, taxes can be a significant expense. Many of the common forms of retirement income are taxable, including Social Security, defined benefit pensions, retirement account distributions, and more. Plus, there are other types of taxes, like property taxes, sales tax, and more.

Taxes may be a part of life, but they can be a burden on your retirement. Every dollar you pay in taxes is a dollar that can’t be used to support your lifestyle and fund your retirement goals.

Fortunately, there are strategies you can implement to minimize your tax exposure and reduce your burden. Below are three such strategies to consider. A financial professional can analyze your needs and goals and help you develop alternative strategies.

 

Consider a Roth IRA instead of a traditional.

Are you one of the millions of people using an IRA to save for retirement? A traditional IRA is a powerful savings tool because it offers tax-deferred growth and potential tax deductions when you make a contribution.

However, a traditional IRA can create tax issues in retirement. All distributions from a traditional IRA are taxed as income. If you use an IRA to accumulate a sizable nest egg, you could face taxes on much of your income in retirement.

The alternative is a Roth IRA. In a Roth IRA, you don’t get tax deductions when you make a contribution. However, your distributions in retirement are tax-free, assuming you are at least age 59 ½ and you have held the Roth for at least five years.

As a married couple, you cannot contribute to a Roth if your income is greater than $196,000 in 2020. For a single person, that limit is $124,000.1 Otherwise, you can contribute up to $6,000 this year, or up to $7,000 if you’re 50 or older.2

You can also convert your traditional IRA to a Roth. This means paying taxes on the traditional IRA amount. However, after the conversion, you can grow the remaining assets in the Roth on a tax-free basis and take tax-free distributions in retirement.

 

Be strategic about Social Security distributions.

Social Security will likely play a role in your retirement income puzzle. However, taxes will impact the net amount you receive from Social Security.

The extent that your Social Security benefit is taxed depends on a number called your “combined income.” Combined income is your adjusted gross income plus nontaxable interest plus half of your Social Security benefit.3

If you are single and your combined income is between $25,000 and $34,000, up to 50% of your benefits could be taxable. If you earn more than $34,000, up to 85% of your benefits could be taxable.3.

For married couples, if your combined income is between $32,000 and $44,000, up to 50% of your benefits could be taxed. If you earn more than $44,000, up to 85% of your benefits could be taxed.

The key to reducing your combined income is to reduce your adjusted gross income. Non-taxable income is not included in that number. So, for example, you could maximize your Roth IRA to minimize your adjusted gross income. You could also delay Social Security until age 70 to increase your benefit, and draw down your taxable accounts, like a traditional IRA, before Social Security starts.

There are a variety of strategies to minimize Social Security taxation. A financial professional can help you find the one that’s right for you.

 

Analyze downsizing or relocating.

Simply moving to a new home could reduce your taxes. Property taxes may be a major tax burden depending on your home. If you no longer need a large home, consider moving to something smaller that has a lower value and thus lower property taxes. You also may look at a neighboring community that has a lower property tax rate.

Another option is to relocate to another state. Some states are more tax-friendly for retirees than others. For example, Alabama doesn’t tax Social Security benefits and has a relatively low sales tax rate.4 Florida is another option as it doesn’t have a state income tax.5 Do your research and you may find a new home that is appealing and saves you money.

Ready to develop your retirement tax strategy? Let’s talk about it. Contact us today at FINANCIAL FIRM NAME. We can help you analyze your needs and develop a plan.

1https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2020

2https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

3https://www.ssa.gov/benefits/retirement/planner/taxes.html#:~:text=Learn%20Apply%20Manage-,Income%20Taxes%20And%20Your%20Social%20Security%20Benefit,on%20your%20Social%20Security%20benefits.&text=between%20%2425%2C000%20and%20%2434%2C000%2C%20you,your%20benefits%20may%20be%20taxable.

4https://money.usnews.com/money/retirement/baby-boomers/slideshows/the-most-tax-friendly-states-to-retire?slide=2

5https://money.usnews.com/money/retirement/baby-boomers/slideshows/the-most-tax-friendly-states-to-retire?slide=4

 

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