Tax Planning: Steps For More Efficient Tax Planning In Retirement

by Enid Kathambi, Money Columnist

Published in Money and Finance on 10th February, 2020

There is an old saying by Benjamin Franklin that there are only two certainties in life death and taxes. Even in retirement, taxes will be there that you can be sure. Tax planning is ideal for every stage of life. This is why we are going to discuss steps for more efficient tax planning in retirement.

You might have aligned your finances and done as much tax planning all your young and working life. But did you consider your tax issues in retirement?


Also, those strategies might not apply during retirement. Now, retirement is already knocking at your door, or maybe you just started your retirement days. New strategies are needed to ensure you do not spend your little savings paying Uncle Sam.

What are your income needs?

The first step to more efficient tax planning in retirement is evaluating your income needs. While at it, identify all your sources of income during retirement.

If your source of income is retirement accounts, you need a strategic plan. Which accounts to withdraw from, when to withdraw, and how much to withdraw. This will help you maximize your wealth and reduce your tax liabilities.

Also, determining your income needs will help you know your tax bracket. The higher your income needs during retirement, the higher the tax bracket depending on that year's tax brackets.

The most common misconception, though, is that all the income is subject to the higher tax rates. The truth is that a higher tax rate will only apply to the portion of your income that surpasses a certain threshold.

Say for example, you are a retiree filing your 2019 returns as a single filer. You have a total income of $50,000. This means that you fall under 3 tax brackets. You will pay 10% on the first $9,875, 12% on any income above $9,875, but not more than $40,125. The remaining balance of $9,875 (50,000 - 40,125) will have a tax rate of 22%.

Try to lower your expenses

The lower your expenses, the less you need to withdraw from your retirement funds every year. This also translates to a lower tax bracket, thus keeping your tax liability as low as possible.

One way to go about it is moving to an affordable neighborhood, where rent and living expenses are low. If possible, you can buy a house in cash in an affordable area too. If moving from the city or your preferred neighborhood is not an option, then move to a smaller house.

lower your expenses

This is where a friendly budget will come in handy. Start with your current spending habits and try to remove any extravagant and unnecessary items firm the list.

Traditional IRA Conversions

Converting your traditional IRA into a Roth IRA might help reduce your tax liabilities, but it does not apply to everyone. Does it apply to you? Then, the question is whether to convert the whole of your traditional IRA or part of it.

Roth IRS do not have tax deductions when contributing. Additionally, your growing investment is not taxed. Income tax does not apply to qualified distributions from the initial to all subsequent growth.

A distribution is considered qualified if it has been in the account for at least 5 years. A penalty also applies for early distributions on the contributions growth for individuals is not yet 59 1/2 years.

A traditional IRA, on the other hand, has tax deductions. Also, the growing contributions are tax-deferred until the age of 70 1/2, until one is ready to receive the distributions or when required to start taking required minimum distributions (RMDs). When one takes distributions for a traditional IRA, the entire withdrawal amount is taxed using the standard income tax rates.

Converting your traditional IRA has the below benefits:

  • It gives your beneficiaries a source of tax-free income and growth for a lifetime
  • Roth IRA has tax-free qualified withdrawals and tax-free accumulation while traditional IRA has a deferred-tax growth
  • Roth IRA does not have any RMD restrictions, while the Traditional IRA has RMD rules. If you are unprepared, the RMD can cause the whole distribution to face the standard income tax rate. This might shift you to a higher tax bracket and ultimately increasing your tax liability.
  • According to the current Tax Cuts and Jobs Act, many provisions will be expiring in 2025. This means that distributions from Traditional IRA and RMDs might have a higher tax repercussion for a retiree

The 4 reasons above sound very promising. However, not every investor benefits from traditional IRA conversion. Also, the initial conversion might have a negative impact on that year's taxes because this amount will be subject to the standard tax income tax rates. The good news is that the above benefits might have a more positive impact on your future taxes.

  • Tax diversification or asset location is also an efficient tax planning strategy for retirement. Diversifying the location of your assets will also help you diversify your taxes. Different investments have different tax rates and implications. It is not wise to have all your retirement investments in the same location.

    The best way to go about this is to have investments in 3 buckets: non-taxable, taxable, and tax-deferred. These could be traditional IRA, Roth IRA, and brokerage. When pulling out your retirement income, you can pick from any of these using a planned strategy that will minimize your taxes.

    You could start pulling from the traditional IRA account up to $77,400 for a married couple and have a tax of 12%. Then, you could withdraw from your brokerage accounts - these face capital gain rates. Finally, you could withdraw from the Roth IRA bucket. Roth IRA should be the last to withdraw from since the money here grows tax-free, and you would want an investment vehicle that increases your investment tax-free.

  • Have tax-exempt investments - If possible, try to make investments in assets that are tax-exempt like municipal bonds. This is ideal for any retiree in a high-income tax bracket. While the returns for these assets are low, the after-tax returns might be better that you would receive with other investments with higher returns once you have included the tax.


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