Maximizing Tax Efficiency When Nearing Retirement

Alecia Decker |

There are tax-intelligent solutions for every stage in life, from accumulating wealth and building a financial foundation in your early earning years to decumulating wealth and preparing to leave a legacy in your late retirement years. Let’s focus on the pre-retirement years, when income is typically at its highest and your vision of retirement is being built.

As retirement approaches, it becomes crucial to focus on tax efficiency to maximize your savings and help ensure a comfortable and financially secure retirement. The strategies you employ can significantly impact your tax burden and, ultimately, the amount of money you have available during your golden years.

Optimize Social Security Benefits

One of the most significant decisions you’ll make is when to start taking Social Security benefits:

  1. Delay Benefits if Possible: If you delay taking Social Security benefits until age 70, your benefits will increase by approximately 8% per year after your full retirement age (FRA).
  2. Coordinate with Your Spouse: If you’re married, coordinating your Social Security claiming strategies can maximize your combined benefits.

Strategic Withdrawals from Retirement Accounts

The order in which you withdraw from your retirement accounts can significantly impact your tax efficiency:

  1. Taxable Accounts First: Consider drawing down taxable investment accounts before tapping into tax-deferred accounts. This can help keep your taxable income low in the early years of retirement.
  2. Roth Conversions: Convert funds from a Traditional IRA or 401(k) to a Roth IRA during years when your tax bracket is lower. Roth IRAs offer tax-free withdrawals, which can be highly beneficial in later years.
  3. Required Minimum Distributions (RMDs): Starting at age 73 (born prior to 1960) or at age 75 (born after 1959), you must take RMDs from traditional IRAs and 401(k)s. Plan ahead to manage the tax impact of these mandatory withdrawals.

Minimize Taxes on Investment Income

Investments can be a significant part of your retirement income. Here are some strategies to minimize taxes on this income:

  1. Capital Gains Management: Hold investments for more than a year to benefit from lower long-term capital gains tax rates. Consider selling assets in years when your taxable income is lower to reduce the capital gains tax rate.
  2. Tax-Loss Harvesting: Offset capital gains with capital losses to reduce your taxable income.
  3. Municipal Bonds: Interest from municipal bonds is generally exempt from federal taxes and, in some cases, state taxes.

Leverage Tax Credits and Deductions

Even in retirement, there are several tax credits and deductions that can reduce your taxable income:

  1. Medical Expense Deduction: If you itemize deductions, you can deduct medical expenses that exceed a certain percentage of your adjusted gross income (AGI).
  2. Charitable Contributions: Donations to qualified charities can provide significant tax deductions. Consider using a Qualified Charitable Distribution (QCD) from your IRA to fulfill RMD requirements while avoiding taxable income.

Plan for Healthcare Costs

Healthcare is a significant expense in retirement, and planning for it can provide tax advantages:

  1. Health Savings Accounts (HSAs): If you’re eligible, contribute to an HSA to benefit from tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.
  2. Medicare Premiums and IRMAA: Be mindful of your taxable income, as it can affect your Medicare premiums. Higher-income retirees may face an Income-Related Monthly Adjustment Amount (IRMAA) surcharge on Medicare Part B and Part D premiums.
  3. Long-Term Care Insurance: Talk to your financial advisor about the pros and cons of long-term care insurance. While it can be expensive, it provides assistance with medical or personal needs over an extended amount of time, which can save money in the long-run.

Consult a Tax-Smart Financial Advisor

Tax laws are complex and ever-changing. Consulting with a tax-smart financial professional who specializes in retirement planning, like those of us at Creason-Edwards & Cimarolli, can provide personalized strategies tailored to your unique financial situation. We can help you navigate the intricacies of tax-efficient withdrawals, charitable giving, and investment management.

Achieving tax efficiency in retirement requires careful planning and strategic decision-making. By understanding your income sources, optimizing Social Security benefits, strategically withdrawing from retirement accounts, managing investment income, leveraging tax credits and deductions, and planning for healthcare costs, you can significantly reduce your tax burden and enhance your financial security in retirement. Start planning early, and consult with a tax-smart financial professional to help ensure you're making the best decisions for your financial future.