After decades of working, saving, and planning, retirement should be the time to reap the rewards. But just because you’ve stopped working doesn’t mean Uncle Sam has retired. Retirement comes with its own tax rules and missing them can cost you. Whether it’s the timing of your withdrawals, a surprise RMD, or a poorly timed Roth conversion, the wrong move can leave money on the table.
Here are five key concepts that can help make your retirement more tax efficient.
Get Strategic About Withdrawals
When you retire, your paycheck stops, but taxes don’t. Withdrawals from traditional IRAs, 401(k)s, and other tax-deferred accounts are treated as ordinary income, and when not managed carefully, can bump you into a higher tax bracket. That, in turn, could impact everything from your Social Security taxation to your Medicare premiums.
That’s why a tax-efficient withdrawal strategy matters. One approach is the “Tax Efficiency Waterfall,” where you draw from accounts in a specific order:
- Taxable accounts first, which may be subject to favorable capital gains rates.
- Tax-deferred accounts second, such as IRAs and 401(k)s.
- Tax-free accounts last, such as Roth IRAs, which allow your money to grow and be withdrawn tax-free.
This isn’t one-size-fits-all advice, but rather a reminder that how you withdraw money can be just as important as how much you withdraw.
Plan Ahead for RMDs
Required Minimum Distributions (RMDs) are another crucial piece of the puzzle. Beginning at age 73 (for most retirees), you’re required to start withdrawing a certain amount annually from your tax-deferred retirement accounts. And the penalties for missing an RMD can be steep—up to 25%, although this may be reduced to 10% if corrected within two years.
But here’s the kicker: your first RMD can be delayed until April 1 of the following year, which can lead to two RMDs in one year and a potential spike in your taxable income.
To avoid surprises, it’s essential to plan when and how you’ll take these distributions. You might even consider drawing down your accounts slightly earlier in retirement to smooth out income over time and stay in a lower tax bracket.
Understand What’s on the Horizon
The tax code is never set in stone. This means income tax rates could rise, affecting retirees who assumed they’d be in a lower bracket during retirement.
Meanwhile, Congress has talked about reducing the estate tax exemption from around $13 million per person. However, each time it comes up as a potential change, it has faded away and not made it into a final bill. If your estate could be affected, proactive planning, including gifting strategies or trusts, may be worth considering.
Roth Conversions: A Powerful Tool When Used Wisely
Roth conversions can be a compelling strategy. By converting some of your traditional IRA or 401(k) assets into a Roth IRA, you pay taxes now in exchange for tax-free withdrawals later. Roth accounts are also exempt from RMDs, giving you more flexibility down the line.
But again, timing is everything.
A Roth conversion may make sense if:
- You expect to be in a higher tax bracket in the future.
- You want to leave tax-free assets to heirs.
- You have cash on hand to pay the conversion taxes.
However, it may not be ideal if:
- The conversion would push you into a much higher tax bracket.
- You need the converted funds in the short term.
- Your beneficiaries will be in a lower tax bracket than you.
A careful analysis can help determine if a Roth conversion is right for you, along with when to execute it.
Don’t Navigate It Alone
Retirement should be a time of freedom and fulfillment, not frustration over tax bills. With the right plan in place, you can feel confident that your money is working as efficiently as possible for you. At ProVise Management Group, we work with clients to develop tax-aware strategies that are tailored to their personal goals, values, and lifestyle. If you’d like to explore these ideas further, you can watch a recording of our recent webinar, Retirement & Taxes: Strategies to Keep More of Your Money, or reach out to schedule a personalized conversation.
ProVise is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal or accounting advice. Tax laws do change and specific questions for your situation should be addressed with your investment, tax and/or legal professional.
