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How Can I Minimize Taxes in Retirement?

Taxes can have a significant impact on one’s retirement years and it is important to question how to minimize those taxes so that there is more to spend when one retires.

Before we dive into various ways to minimize taxes, I want to address and dispel two common myths.

Two Common Myths:

  1. Does moving into the “next tax bracket” mean that all my income starts getting taxed at that higher rate?
    The answer is NO. Only the dollars that exceed that bracket threshold get taxed at that higher rate.
  2. Do I have to pay income tax on gifts I receive?
    The answer is NO. Income tax is a completely different system than the gift & estate tax system. Most people are aware of the $15,000 annual gift limit. However, if you gift more than $15,000 in one year to any one individual, it simply starts to eat into each person’s lifetime limit which is currently set at $11.7 million. The bottom line is: most people do not ever have to worry about how much they gift to someone else.

With this foundation in mind, let’s proceed to the nine ways you can reduce your taxes in retirement.

Nine Ways to Reduce Taxes

  1. Build Wealth in the Right Accounts – Is it better for you to contribute to Roth accounts or traditional accounts? Roth contributions are taxed immediately, but are tax free when making qualified withdrawals. Traditional contributions are the exact opposite. You receive a tax deduction now, but must pay tax when withdrawing in the future. If you think your tax rate will be higher in the future, making Roth contributions may be the better option.


  1. Max out your Health Savings Account – Your health savings account is a dynamic tool. Contributions are tax-deductible and withdrawals are tax-free when used on qualified health expenses. If you can contribute every year and invest it, this account can be the most powerful account you own.


  1. Consider Roth Conversions – Roth conversions allow you to pay tax on a portion of your traditional IRAs now instead of in the future. Once you convert, the money goes into your Roth IRA to grow tax free. If you are in a particularly low-income year or have large deductions resulting in a lower tax rate than normal, it may be a great year to do a Roth conversion.


  1. Invest in a Tax-efficient Way – As we’ve addressed, each account gets taxed in different ways. Therefore, it can make a lot of sense to put certain investments into specific accounts. As an example, mutual funds with large capital gains distributions or income-generating investments may be best in a retirement account with that tax umbrella, whereas tax-efficient ETFs and municipal bonds could make more sense in a non-retirement account.


  1. Donate Via a Qualified Charitable Distribution – Donating via a qualified charitable distribution is a special way of donating directly from your traditional IRA to a charity. The biggest benefit is that you do not have to “itemize” on your tax return to benefit from this strategy. Instead of paying tax on your “required minimum distribution,” you can send it to a charity instead. Keep in mind that this is only beneficial if you have a charitable intent in the first place.


  1. Donate Appreciated Stock to Charity – If you gift $15,000 of stock or $15,000 of cash, you generally receive an equal deduction on your tax return. The embedded long-term gain in the stock would result in you paying tax if you sold it. However, if you were to give it to charity, they would not have to pay the tax! In essence, you are avoiding the capital gains tax yourself while still getting the same deduction. If you really like the stock, you can simply buy it back with the cash you were going to donate in the first place.


  1. Gift Appreciated Stock to Children – This strategy is similar to the last, but instead of donating the appreciated stock, consider gifting it to your children. If your children have a lower tax rate, gift the stock to them to sell instead of you. Keep in mind that long term gains have a different tax rate than the normal ordinary income rate you might pay on your wages.


  1. Design a Tax-efficient Retirement Income Plan – Just as building wealth in the right accounts is important, so is deciding the order in which you plan to withdrawal money from them. The tax-free growth of Roth IRAs generally means you want to withdrawal from those accounts last. Traditional IRAs have a required distribution at age 72. And withdrawing from non-retirement accounts all depends on how much tax you would have to pay on realized gains. Ultimately, this answer will vary every single year depending on tax law and your personal income circumstances.


  1. Move to a Tax-friendly State – Moving to a tax-friendly state can turbocharge one’s ability to retire! Some states have low- or no-income tax. Some states have low- or no- sales tax. Some states have low property tax. The best state for you will depend on your own circumstances, but it is important to factor in the impact of all the types of tax. A great place to compare the tax situations in different states can be found here:

While all these strategies can help you reduce taxes, every person’s situation is unique. For this reason, we highly encourage you to implement these strategies alongside an advisor who has an in-depth understanding of tax law. Every dollar of taxes saved is a dollar you can spend on something else in retirement!

Financial Consulate aims to help lessen the worry and burden of wealth management and enhance financial wellness so our clients can pursue relationships and true fulfillment. Choose the professionals at Financial Consulate as your Certified Financial Planners™ (CFP®) to take advantage of our educational, ethical approach to financial planning. Our services are comprehensive, including tax planning, investment planning, retirement planning, estate planning, and more. We operate completely independently and offer fee-only services to keep your vision in line with our recommendations at all times. While we have offices in Hunt Valley, Maryland, Fernandina Beach, Florida, and Gettysburg, Pennsylvania, we serve clients across the nation. To begin your partnership with a trustworthy wealth advisor, please contact Financial Consulate today.

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