Minimizing Taxes on Your Income Retirement
Retirement means that you're done working full time, but it doesn't necessarily mean that you're done making money. More and more retirees are taking part-time jobs in retirement. Others start their own companies and draw a new kind of salary: the CEO's!
You'll pay taxes on those wages using the same bracket formulas and forms you used to pay taxes on your old salary. But once you crack open your nest egg and start thinking about taking Social Security, your retirement tax picture can get very complicated very quickly.
Whether or not you get a job in retirement, all retirees need to recalibrate their tax plan around two critical income sources. If you don't, you could end up paying higher taxes in retirement than you did while you were working.
1. Social Security
Up to 50% of your Social Security benefits may be taxable for retired individuals earning more than $25,000 per year and retired couples earning more than $32,000. For individuals earning more than $34,000 and couples earning more than $44,000, up to 85% of your benefits may be taxable.
One way to avoid paying taxes on Social Security is ... wait to take Social Security! If you don't need Social Security to cover your monthly expenses, you should consider delaying taking it until your benefit level maxes out at age 70.
If you are already taking Social Security, then you might explore ways to reduce your levels of taxable income without negatively impacting your budget and your goals for bucket list trips and purchases. Tax-loss harvesting strategies can lower your taxable income from investment accounts. Some folks also are strategic about bunching itemized deductions into one calendar year including perhaps making a contribution to a donor advised fund. You might also delay selling a piece of property or a classic sports car to avoid a bump in capital gains.
Or, you might compare what you're making at that part-time job to what it's costing you on taxes on your Social Security benefits. Many seniors reach a point where working more just doesn't pay off anymore. It could be time to clock out for good and start focusing on other meaningful activities, such as volunteering, sports, continuing your education, or improving your craft or hobby skills.
At the end of 2019, the SECURE Act made some significant changes to how both traditional and Roth IRAs work. First, the government allowed seniors to keep contributing to traditional IRAs for as long as they're working. The age at which retirees need to start taking required minimum distributions (RMDs) also went up from 70 1/2 to 72.
Coordinating these changes with your Social Security strategy can make a big impact on your taxable income level, particularly if you have both a traditional and a Roth IRA in your portfolio. For example, withdrawals from a Roth IRA are not taxable. Withdrawals from a traditional IRA are. But if you're still working part time in retirement, you might still be eligible to make tax-deductible contributions to a traditional IRA, thus lowering your overall taxable income.
Converting a traditional IRA into a Roth IRA can also be advantageous for some seniors. However, any pre-tax money you convert will be counted as taxable income in the year of the conversion.
Another strategy is to take penalty-free early withdrawals from your retirement accounts after age 59 1/2 and reinvest that money into an after-tax investment account or an account you've earmarked for retirement expenses. Yes, you’ll pay some taxes today but may well save tax on Social Security once you decide to start your benefits.
Always look ahead.
You might have noticed that the further we get into the details of taxes, Social Security, and RMDs, the broader the scope of the planning process becomes. Too many soon-to-be retirees don't realize how converting an IRA or taking Social Security in their 60s creates ripples that can alter their retirement for decades.
And we’ve only discussed two retirement income sources here! Pensions, investment accounts, annuities, personal property, and inheritances all have distinct nuances that must be accounted for to make sure you get the best life possible with your specific assets in retirement.
Before you cash that first Social Security check or start taking early withdrawals, call up my team of fiduciary advisors. You've worked too long and too hard to let unintended consequences keep you from living the retirement of your dreams.
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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