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7 Tips for Minimizing Your Income Tax in Retirement

income tax

After a lifetime of making money and paying your taxes, you’re entitled to enjoy the fruits of your labor during retirement. But if your total assets amount to more than $1 million, you could end up paying far more tax than you ever expected.

Maximizing your retirement income and protecting your assets has the potential to enhance your retirement. And the more tax you can legally avoid, the more you’ll have to hand down to your heirs.

Careful financial planning should begin during the years before you leave the workforce. After all, the chances are you’ll be taxed on both your Social Security benefits and your investments. Fortunately, there are ways to minimize your liabilities — but they all require expert advice and careful execution.

1. Reduce Your Monthly Expenses

This is possibly the simplest thing you can do to minimize your retirement tax burden. The less money you spend on expenses every month, the less you’ll have to withdraw from retirement funds and investments. As most taxes apply to withdrawals and distributions, this principle should guide all of your thought processes and actions when planning your finances.

While you obviously want to enjoy the wealth you’ve amassed over the years, it’s still important to think carefully before committing to long-term expenses. If you can remain under the 15 percent tax band, you’ll be able to exploit several tax breaks.

2. Pay Off Your Mortgage Early

Sitting on significant assets during the last few years of your working life puts you in a very strong position in terms of retirement income options. For example, if you have the cash available to pay off your mortgage early, you should take it.

For most people, a mortgage repayment is their single largest expense; remove it, and it’s much easier to keep monthly expenses within the 15 percent or 20 percent tax brackets. Sell your house before you stop working, and you’ll be able to take advantage of significant tax breaks. You’ll also have a greater degree of flexibility when it comes to retirement planning for the long term.

3. Diversify Your Investments

If you’ve amassed significant assets over the years, the final years before retiring should be spent planning a range of investments. Look into pouring your funds into as many investment vehicles as possible, including IRAs, property, savings accounts, bonds, brokerage accounts, pensions and Social Security.

Using the correct combination of retirement investments will help you minimize your taxable income and remain under the 15 percent or 20 percent tax brackets. Start investing your funds for retirement while you’re still at work, as you’ll probably have more options to choose from.

4. Be Careful With Your Withdrawals

It’s only right that you have the retirement income you need to fund the lifestyle you’ve earned. But every withdrawal or distribution you make needs to be thought about carefully. Wherever possible, try to delay withdrawals from tax-deferred accounts for as long as possible.

Withdrawals from some of your accounts might be taxed at rates of up to 20 percent, while others (including IRAs) might be taxed as standard income — or not at all.

5. Switch to a Roth IRA and Roth 401(k)

If you have cash in standard IRAs, it might be worth your while diverting some of it to Roth alternatives. This move might reduce minimum distributions in the future, depending on your personal circumstances at the time.

Retirement funds in Roth accounts aren’t taxed if the withdrawals meet certain qualifying criteria. If you’re over 60 and transferred the funds five or more years ago, you might be able to make some tax-free withdrawals. However, this can be a complex area, so you should seek the advice of a tax advisor before proceeding.

6. Choose the Right Tax Bracket

It’s important to estimate your annual taxes in advance to see if there’s scope to change your tax bracket and take advantage of some significant reductions. If you find that your income is less than the maximum allowed in your current tax bracket, it might be worth your while withdrawing from an IRA to make up the difference. If your IRA is relatively large, it might make economic sense to make withdrawals early.

7. Utilize IRA Charitable Distribution

Under existing tax rules, you’re allowed to use your IRA’s minimum distribution to donate money to charity — a move that delivers a number of benefits. By sending IRA money directly to charity, you can reduce your income to well below the minimum distribution amount, and slash your tax bill. This move can also help you to avoid increased Medicare premiums and reduce tax liabilities on Social Security income.

In truth, there are many more ways to reduce your tax burden during retirement, including taking losses on investments and switching to a reverse mortgage. But the combination of methods used to minimize your taxes during retirement depend heavily on your circumstances. By planning for your retirement with the help of experienced retirement planning experts, you can enjoy more of the money you’ve worked a lifetime to earn.