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9 Ways to Reduce Taxes on Your Retirement Accounts


Having multiple streams of income for retirement can help you feel more financially secure. Minimizing the amount of taxes you pay can help you preserve more of your savings.There are actually a few ways to avoid taxes on your retirement accounts. Getting familiar with how different types of retirement income are taxed can help with developing a strategy for reducing what you owe. You can also talk to a financial advisor about creating a tax-efficient retirement savings plan.

Understanding Taxation of Retirement Income

With a few exceptions, most retirement income is subject to tax. How tax is applied can depend on the type of income in question.

  • Traditional 401(k) plans and IRAs: Traditional 401(k) plans and traditional IRAs are funded with pre-tax dollars. That means that qualified withdrawals from those plans are subject to ordinary income tax. The same rules apply for other workplace plans, including 403(b) plans and 457 plans, as well as SEP and SIMPLE IRAs. You do, however, get the benefit of tax-deductible contributions with these accounts. These plans require minimum distributions beginning at age 73. Failing to take these distributions can result in a tax penalty equal to 50% of the amount you’re required to withdraw. Early withdrawals from these plans made before age 59 ½ can also result in a 10% tax penalty.
  • Roth 401(k) plans and Roth IRAs: Roth 401(k) plans and Roth IRAs are funded with after-tax dollars, so you don’t get any type of deduction for contributions. However, qualified withdrawals are tax-free. Additionally, Roth IRAs don’t obligate you to take required minimum distributions (RMDs). They’re required for designated Roth 401(k) plans through the end of 2023, but that rule goes away in 2024. The early withdrawal penalty can also apply to Roth 401(k) and IRA plans. You can, however, withdraw original contributions to a Roth IRA at any time without a tax penalty.
  • Social Security benefits: Social Security benefits may be taxable, depending on your overall income and filing status. The IRS considers income from wages, self-employment, interest, dividends and other taxable sources when determining whether benefits are taxable or not. If they are, you’ll pay tax on 50% or 85% of your Social Security benefits, depending on the amount of income you have.
  • Pension and annuity income: Pensions and annuities can provide a steady stream of income in retirement, but payouts can increase your taxable income. Pension and annuity benefits from qualified retirement plans are tax-deferred, meaning distributions are taxed as ordinary income when you retire. There’s an exception for distributions from designated Roth accounts. If you purchase an annuity from an annuity company, your tax liability depends on how it was funded. If you purchased the annuity with pre-tax dollars, withdrawals are taxed as ordinary income. Annuities funded with after-tax money are also taxed, but only on the earnings.
  • Taxable investment accounts: Taxable investment accounts are subject to capital gains tax. Whether you pay the short-term capital gains tax rate, or the more favorable long-term rate, depends on how long you hold investments in your account before selling them. Assets held for less than one year are taxed at the short-term gains rate, while assets held for more than one year are treated as long-term capital gains.

How Can I Avoid Paying Taxes on Retirement Income?

Minimizing or avoiding taxes on retirement income can take some planning but it can be well worth it to preserve more of your wealth. Talking to a financial advisor can help you figure out the best ways to reduce taxes based on your personal situation. Here are some of the strategies an advisor might recommend.

1. Fund Roth accounts: As mentioned, income from Roth accounts isn’t subject to income tax since you’re contributing after-tax dollars. If you have the option to choose a Roth 401(k) at work or you’re eligible to save in a Roth IRA, you might consider doing so to reduce taxation later. For 2023, you can make a full contribution to a Roth IRA if any of the following are true:

  • You file single or head of household and your modified adjusted gross income (MAGI) is less than $138,000
  • You’re married, file separate returns didn’t live with your spouse during the year and your MAGI is less than $138,000
  • You’re married and file a joint return or are a qualifying widow(er) and your MAGI is less than $218,000

Contribution amounts begin to phase out once you pass these income thresholds, eventually dwindling down to $0.

2. Convert to a Roth account: If you’re not eligible to contribute to a Roth IRA because of your income, there’s a workaround you might consider. You could first contribute funds to a traditional IRA, then convert them to a Roth account.

There is a tax consequence since you’d have to pay ordinary income tax on the converted amounts at the time you move those assets to a Roth IRA. However, you’d reap tax benefits over the longer term as qualified withdrawals would be tax-free.

3. Roll traditional IRA funds to an HSA: Health Savings Accounts (HSAs) allow you to save money for health care expenses on a tax-advantaged basis. Contributions are tax-deductible, growth is tax-deferred, and withdrawals are tax-free when used for qualified medical expenses. If you have a traditional IRA, you could roll money from it into an HSA if you have access to one through a high-deductible health plan (HDHP).

You could then make tax-free withdrawals for health care in retirement. If you stay healthy, you could withdraw money from your HSA for any other purpose. You’d just pay ordinary income tax on distributions. Keep in mind that if you’re under age 65 and make a non-qualified withdrawal, you’d owe a 20% tax penalty along with income tax. So, it’s important to choose your timing for non-qualified distributions carefully.

4. Make qualified charitable distributions (QCDs): If you have a traditional IRA and are over 70 ½, you could make qualified charitable distributions to offset required minimum distributions. The IRS allows you to treat distributions made directly from a traditional IRA to an eligible charity as a QCD and excludes them from taxable income.

You can exclude up to $100,000 this way and satisfy your RMD elections for the year. Making RMDs on time is important, as the IRS can penalize you for not taking them. As mentioned, the penalty is 50% of the amount you’re required to withdraw.

5. Invest in tax-exempt bonds: Bonds can provide a safe haven for retirement savings and some of them can offer tax benefits. Municipal bonds, for instance, are exempt from federal income tax and in some cases, they may be exempt at the state level as well. The interest rate you earn with municipal bonds compared to something like a high-yield bond may be less, but if tax savings is your primary goal they can help you to achieve it.

6. Choose a tax-friendly state: In addition to federal income tax, it’s also important to consider how state taxes might impact retirement income. Moving to a state with no income tax or a state that doesn’t tax Social Security benefits could yield some decent savings. Of course, it’s a good idea to weigh the overall cost of living in a new state to make sure that any money you save on taxes isn’t just being redirected to housing or other expenses.

7. Opt for direct rollovers: Rolling money from one retirement account to another is something you might consider if you want to consolidate savings or simply keep your money in a different place. Choosing a direct rollover can help to minimize negative tax consequences.

With a direct rollover, funds move from one account to the other without any money ever touching your hands. If you were to request an indirect rollover, a check would be sent to you. You’d then have 60 days to deposit it into the new account. The catch is that if you get the timing wrong, the entire amount is treated as a taxable distribution.

8. Consider a buy-and-hold strategy: If you’re investing in stocks, mutual funds or other securities through a taxable brokerage account, it’s important to be mindful of capital gains. From a tax perspective, it’s to your advantage to hold onto assets for longer than one year so that when you sell them, any capital gains are subject to a lower tax rate. Your financial advisor can guide you on which investments may work best for a buy-and-hold approach.

9. Harvest losses: Tax-loss harvesting allows you to offset capital gains with capital losses.  You can use losses to offset all of your gains for the year, and up to $3,000 in ordinary taxable income if your total losses exceed your gains. Harvesting losses isn’t an appropriate strategy 401(k) plans or IRAs, but it could result in significant savings if you’re investing for retirement in a taxable brokerage account.

Bottom Line

Reducing the amount of taxes you pay on retirement income can leave you with more money to cover day-to-day expenses or fund your dream lifestyle. The options included here are just some of the ways to lower your tax bill in retirement. Talking to a financial advisor can help you create a customized plan for managing tax liability.

Retirement Planning Tips

  • Creating an estimated retirement budget can give you a better idea of whether you’re on track with your current savings rate and what adjustments you might need to make, if any. You can have a financial advisor look over your plan and offer suggestions for improving it, if you have one. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Choosing the right age to retire can influence your tax situation, as it may determine when you begin drawing down your savings. Age also matters when deciding when to take Social Security benefits.

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