How to minimize your taxes in retirement

Image1Take steps now to learn how to minimize your taxes in retirement.

You worked hard to save money for retirement, but when you withdraw the funds, you may be surprised by your retirement tax bill. If you aren’t careful, your tax bill could take a sizable bite out of your retirement income.

Ways to avoid paying taxes on retirement income

Retirement tax strategies come in handy for preserving your nest egg. Read on for more tips on how to do so.

Utilize tax-exempt retirement plans

If you’re wondering how to avoid paying taxes on retirement income, you should take advantage of a tax-exempt retirement plan. Tax-exempt retirement plans consist of contributions from after-tax dollars. Some of these accounts include:

  • Roth 401(k)s

  • Roth IRAs

  • Health savings accounts (HSA)

  • Medical savings accounts (MSA)

Upon retirement, you pay no tax on the money taken out if you make qualified withdrawals. The benefit to such tax-exempt retirement accounts, like Roth 401(k)s and Roth IRAs, is that the income your plan earns over time is tax-free when withdrawn.

You can also deposit funds in a tax-free savings account (TFSA) that offers tax benefits on savings and earnings, for example from interest. A health savings account (HSA) is a type of TFSA used to save money for future medical expenses. You get a tax deduction for the money you contribute, plus any interest or account growth from investments is tax-free. If you use the money for qualified medical expenses, you won’t pay tax when you withdraw the money. A medical savings account (MSA) works similarly to an HSA. However, an MSA is used by Medicare recipients, self-employed individuals, and small business employees.

Tax-free investments can also reduce taxes in retirement. Earnings from treasury bonds are usually exempt from federal and state taxation, whereas municipal bonds avoid federal taxes.

Certain states, like Tennessee or Florida, don’t charge tax on some retirement income, such as Social Security benefits or 401(k) withdrawals. Consider lowering your tax burden by retiring in states that do not tax retirement income. Let FinanceHQ connect you with a financial expert who can help you navigate the retirement landscape.

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More strategies to lower your tax burden in retirement

Although you may not entirely eliminate your tax bill, tax strategies for retirement can help reduce the impact.

  • Minimize income. The IRS calculates the percentage of taxes you must pay based on your tax bracket. If you can maximize deductions or delay your income, you may be taxed at a lower tax rate.

  • Avoid early withdrawal penalty. You could be subject to a 10% penalty if you withdraw funds from your retirement account before you reach age 59 ½. While the IRS allows some exceptions to this penalty, always be sure to check with your financial advisor or tax accountant before making an early withdrawal.

  • Pay attention to RMDs. Required minimum distributions, or RMDs, are the minimum amounts you must withdraw annually from most retirement accounts. The retirement age for RMDs has varied between 70 ½ and 73 — depending on the year you turned 73. For 2023, you must begin taking RMDs once you hit 73 years old. Failure to take your RMD could result in a hefty 50% penalty.

  • Delay 401(k) withdrawals. If you continue to work after age 70 and don’t own 5% of the company sponsoring the retirement plan, you may be able to delay withdrawals until you retire. If you have retirement accounts associated with other employers, you must take RMDs once you hit age 73 from these accounts.

  • Time your retirement withdrawals. Spacing out your withdrawals strategically, for example during lower-income years, can reduce the tax rate applied.

Work with a professional

The taxes you pay in retirement can be confusing and subject to complex rules. By working with a professional financial advisor or retirement planner recommended by FinanceHQ, you can maximize the money you keep from retirement savings. These financial advisors can also answer your most important questions, like how much you should have saved for retirement.

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Anna Yen
Written byAnna YenContributing writer

Anna Yen is a CFA charterholder, financial wellness expert, writer, and investor at FamilyFI.