Minimizing Your Tax Burden in Retirement

If you think you don’t need to worry about taxes in retirement, think again. Although your taxable income will probably be much lower than when you were in the workforce, you could still get hit with capital gains taxes on your investments, property taxes, and other expensive surprises if you don’t plan ahead. Here are five simple tips for reducing your tax burden in retirement:

  • Avoid Spikes in Income
    If you take a lump-sum payment from an employer-sponsored retirement or pension plan, you could face a whopping tax bill. Consider rolling over the assets into an IRA and taking distributions on a regular basis rather than withdrawing all the money at once.
  • Don’t Roll Employer Stock into Your IRA
    If your employer retirement account contains employer stock that has appreciated significantly, consider taking the shares of stock rather than rolling it over into an IRA. If you take the stock, you will owe tax on your original cost of the shares—which may be a fraction of their current worth. You won’t owe taxes on the rest of the value until you sell the shares, and even then, you’ll pay a lower federal capital gains tax. That’s much better than rolling the stock into an IRA and owing ordinary income tax on all the funds you withdraw.
  • Save Tax-Deferred Income for Last
    If you have an IRA or other qualified retirement plan, spend your other funds first, so you take advantage of the tax deferral for as long as possible. The only exception is that if you are in a low tax bracket now, and expect that your minimum distributions from your IRA at age 70½ will be large and thus taxed at a higher rate, you should begin taking distributions now to thin down your retirement funds. That is not true of money in a Roth IRA, that grows tax free, not just tax deferred. Since Roth IRAs do not require minimum distributions at age 70½, those funds should be the last money you withdraw, so you maximize the tax-free growth.
  • Time Your Capital Gains
    If you sell stocks or mutual funds that have appreciated over time, sell the shares with the highest basis, to reduce the amount of taxable gain.  If you have stocks or mutual funds that have decreased in value, sell some of them to realize losses that will offset your gains, thus reducing your tax bill.
  • Pick a Tax-Friendly State. You can save a bundle by relocating to a state with low taxes. For example, Florida, Washington and Texas are no-income-tax retirement meccas, while Delaware doesn’t charge sales tax and has a low property tax rate. Even within the same state, certain towns are more tax-friendly than others, so be sure to shop around before putting down roots.

You’ll find many other helpful tax tips in the booklet
150 Ways to Save Taxes Through Life’s Transitions.

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