Tax Planning for Retirement: Keep More of Your Hard-Earned Money!

As you get closer to retirement, it’s natural to focus on how much you’ve saved and whether it’ll be enough to support you once you stop working. But here’s something that often gets overlooked: taxes. The way you manage your taxes—before and after retirement—can make a huge difference in how far your savings will go.

In this article, we’ll walk you through the basics of tax planning for retirement, offering practical tips to help you make smarter decisions now that will pay off later. The good news is, it’s never too early to start thinking about it and if you’re here, you are already ahead of the curve!

Know Where Your Retirement Income Will Come From

First, let’s take a look at where your retirement income will likely come from. Understanding the different sources of income can help you plan how to reduce taxes and stretch your savings.

Social Security: Most people rely on Social Security for a chunk of their retirement income. The tricky part? Depending on your total income, a portion of your Social Security benefits might be taxable. For most retirees, up to 85% of your Social Security benefits could be taxed. But the more other income you have, the higher that percentage can go.

401(k)s and IRAs (Traditional): These accounts are tax-deferred, meaning you don’t pay taxes on the money you contribute now, but you will pay taxes when you withdraw it in retirement. The key to remember is that these withdrawals will be taxed at your regular income tax rate, which could be higher than you expect, especially if you’re not prepared.

Roth IRAs and Roth 401(k)s: The beauty of Roth accounts is that you pay taxes on your contributions now, but your withdrawals are tax-free when you retire, as long as you meet the conditions. This is a great option if you expect to be in a higher tax bracket later on or want to avoid paying taxes on your retirement income altogether.

Pensions: If you’re lucky enough to have a pension, those payments are usually taxable as ordinary income, just like a paycheck would be.

Investment Income: If you have investments in a taxable brokerage account, you’ll pay taxes on any interest, dividends, or capital gains when you sell those investments. Long-term capital gains, for investments held more than a year, are usually taxed at a lower rate than short-term gains, so it’s worth thinking about how you manage your investments in the years leading up to retirement.

Choose the Right Accounts to Save In

As you save for retirement, think about which type of accounts will give you the most tax advantage.

Tax-Deferred Accounts: These are your traditional 401(k), 403(b), and IRA accounts. The big draw here is that you get to lower your taxable income in the year you contribute. So, if you put $10,000 into a 401(k), your taxable income for the year drops by $10,000, which can result in immediate tax savings. The downside is you’ll have to pay taxes when you withdraw the money in retirement. If you expect your income and tax rate to be lower in retirement, this can work out well.

Tax-Free Accounts (Roth Accounts): Roth IRAs and Roth 401(k)s are a little different. While you don’t get a tax deduction when you contribute, the beauty of these accounts is that qualified withdrawals in retirement are 100% tax-free. If you think you might be in a higher tax bracket in retirement, or you simply want to avoid the hassle of paying taxes on your retirement income, Roth accounts are a powerful tool.

***Tip: It’s a good strategy to have both types of accounts. If you’re in a high tax bracket now, focus on contributing to tax-deferred accounts. If you think your tax rate will go up later, or if you want to minimize future taxes altogether, build up a Roth account too.

Create a Smart Withdrawal Strategy

You’ve worked hard to save. Now the goal is to make your money last in retirement. How you withdraw money from your accounts can make a big difference in your tax bill.

Withdraw from Taxable Accounts First: If you have investments in taxable accounts, like stocks or mutual funds, consider tapping these accounts first. This is because long-term capital gains on investments held for more than a year are taxed at a lower rate than regular income. You can often save on taxes by using these funds early on.

Use Tax-Deferred Accounts: Once your taxable accounts are tapped out, it’s time to dip into tax-deferred accounts like your traditional IRA or 401(k). Be aware, withdrawals from these accounts are taxed as ordinary income, so you may end up paying a higher tax rate depending on how much you withdraw.

Roth Conversions: Another tactic is converting some of your tax-deferred funds into a Roth IRA before you reach age 73, the required minimum age where distributions or RMDs kick in). While you’ll pay taxes on the conversion now, it could save you in the long run, especially if you expect your tax rate to increase or you want to avoid paying RMDs later. These will be explained further in the next section.

Minimize Required Minimum Distributions (RMDs)

Starting at age 73, the IRS requires you to start withdrawing a certain amount from your traditional 401(k) or IRA each year—these are called Required Minimum Distributions (RMDs). The downside is that they’re taxed as ordinary income, which can push you into a higher tax bracket, increasing your tax bill.

Roth Conversions: One option is to convert some of your traditional retirement funds into a Roth IRA before you hit age 73. With a Roth, you won’t be required to take RMDs, which helps reduce your tax burden in retirement.

Give to Charity: If you’re charitably inclined, consider making Qualified Charitable Distributions (QCDs) from your IRA. You can donate up to $100,000 directly to a charity each year, and it counts toward your RMD—without being taxed. It’s a great way to lower your taxable income and give back to the causes you care about.

Take Advantage of Deductions and Credits

Even in retirement, there are ways to reduce your tax bill. Don’t miss out on tax breaks that could help lower your income taxes!

Medical Expenses: If you itemize your deductions, you can deduct medical expenses that exceed 7.5% of your adjusted gross income (AGI). As healthcare costs rise, this can be a significant deduction for many retirees.

Standard Deduction: Most retirees will find that the standard deduction is more valuable than itemizing deductions. For 2024, the standard deduction is $27,700 for married couples filing jointly and $13,850 for single filers. This can lower your taxable income significantly, especially if you don’t have a lot of other deductions.

Tax Credits: If you’re over 65 and have a lower income, you may qualify for the Credit for the Elderly or Disabled, which can further reduce your tax bill.

Working in Retirement? Don’t Forget the Tax Impact

Many retirees choose to work part-time or start a side business. That extra income can be helpful, but it can also affect your taxes.

Social Security Taxes: If you’re already collecting Social Security and your earnings from work are above a certain threshold, a portion of your benefits may become taxable. The more you earn, the higher the percentage of your benefits that will be taxed. For more information, visit the Social Security Administrations website.

Pension and Income Taxes: If you’re receiving pension payments and/or have other sources of income like wages from part-time work, you may end up in a higher tax bracket. This could increase your tax liability.

Final Thoughts

Start Planning Today!

Retirement is intended to be a time to relax and enjoy life—but if you’re not careful about how you handle taxes, it can also be a time of surprises. As you start thinking about how to balance your retirement accounts, minimize your tax burden, and take advantage of deductions and credits, you are taking a proactive approach to tax planning. It’s not just the start of a new chapter—but a financially healthy one too!