2014-11-12 11:59:34 Taxes English Unfortunately, retirement income taxes are inevitable, but here are five simple ways for retirees to reduce their tax burdens. https://d2yxjugd6jl4bj.cloudfront.net/wp-content/uploads/2014/11/08232645/2014_11_10-large-am-retirement_income_taxation_tips_to_avoid_overpaying.png Retirement Income Taxation: Tips to Avoid Overpaying

Retirement Income Taxation: Tips to Avoid Overpaying

4 min read

For members of the working world, taxes tend to be an unpleasant yet largely bearable fact of life. However, when it comes to retired individuals, taxes are often far more than a mere inconvenience.

According to a recent article by U.S. News & World Report, retired persons should aim to keep their taxable income below the 15% bracket to protect their nest eggs. And while your tax burden will likely decrease as you stop working, some retirees may find themselves paying uncomfortably high tax rates on savings accounts, pensions and other income sources.

To make sure your golden years stay comfortable, here are five ways to reduce your tax burden as a retiree.

1. Relocation

Want to reduce your tax liability as a retired person? You may want to think about relocating to a state without income taxes.

While this choice seems like a drastic one, the truth is that the place where you live can have a serious impact on your quality of life during retirement. Not only do states like Florida, Nevada and New Hampshire not tax Social Security earnings, but they also refrain from taking taxes out of pension incomes. As a result, seniors can feel confident knowing their nest eggs will last longer.

Of course, relocation is not a viable option for all seniors. If you’re unable or unwilling to leave your home state behind, you may want to consider purchasing municipal bonds. Ideal for seniors in a higher tax bracket, municipal bonds aren’t generally taxed by federal or state governments. And with thousands of new-issue and secondary-market bonds available at any given time, seniors have plenty of options to choose from.

2. Roth IRAs

When it comes to retirement savings, not all investments are created equal. To minimize tax burdens during your golden years, you may want to convert traditional assets into Roth IRAs.

Also known as “Individual Retirement Accounts,” Roth IRAs allow you to grow your retirement savings without paying the taxes you’re required to pay on traditional IRAs. In general, persons under age 50 can contribute up to $5,500, while older individuals can put in up to $6,500 annually. Additionally, seniors can typically continue contributing to their Roth IRAs throughout retirement and make withdrawals without having to pay a penalty.

Not all retirees are eligible for a Roth IRA. To see if you qualify for an account, see RothIRA.com.

3. Asset Diversification

If you’re researching retirement savings options, then you’ve probably heard the phrase “asset diversification.” And while it sounds simple, choosing the best and most tax-efficient investments can be a complicated matter.

In general, assets are classified as taxable, tax-deferred or tax-exempt. Tax-deferred accounts allow you to make tax-free contributions, but you’re then taxed when you begin making withdrawals from the account. Tax-exempt accounts are the opposite: Contributions are made with after-tax dollars, while withdrawals can be taken without incurring taxes.

By striving to invest in tax-deferred and tax-exempt funds, you can maximize your income upon retirement while limiting tax liability. Some of the best tax-efficient investments include:

  • Index funds: Along with their low initial costs, index funds are traded less often than other investments, meaning they result in less taxable income. 
  • Stock mutual funds: A popular investment option, mutual funds require you to pay taxes only when you withdraw pre-tax contributions and earnings. 
  • Exchange-traded funds: Also known as “ETFs,” these funds allow for intraday trading and permit investors to defer most taxes until the investment is sold.

Whenever possible, seniors should avoid junk bonds and common stocks. Not only do these investment options come with a higher risk factor, but they are also inefficient for tax purposes.

4. Asset Transfers

Of course, smart investment choices aren’t the only ways to maximize tax savings. Seniors looking to reduce their tax burdens prior to retirement may want to consider transferring savings to children and grandchildren.

Often tax-deductible, these gifts allow you to limit taxable income while helping out your loved ones. According to federal law, you can transfer up to $14,000 to any person (including corporations) in a given year without having to pay federal gift tax. Gifting to family and friends is also a great way to avoid estate taxes that can reduce your assets after death.

5. Charitable Contributions

Want to reduce your tax burden while giving back to society? Consider making a charitable contribution to one of your favorite organizations.

Not only do charitable donations lower your taxable income, but they also allow you to make itemized deductions on your tax return. Just make sure the beneficiary you choose is a qualified charitable organization, so you can enjoy all the possible tax savings that go along with your gift.

Start Reducing Your Retirement Tax Burden Today

The truth is that paying taxes during retirement is a fact of life, and even the best financial planners can’t eliminate your tax burden entirely. However, with careful research and planning, you can minimize your tax liability during retirement while ensuring that your golden years stay stress-free.

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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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