Key Tax Planning Strategies to Consider Prior to Retirement

Morgan Ranstrom |

What are the key tax planning strategies you should consider prior to retirement?  

Tax planning is one of your retirement plan's most crucial yet underappreciated (and under-reviewed) aspects. Why? Well, first of all, taxes are hard. For example, a simple financial decision affects your income number, which affects your tax rate and the amount owed on your tax return. Clearly, your tax plan should be a core aspect of your financial plan.

Tax planning requires a holistic approach to your overall financial life. 

Interestingly, most financial advisors aren't actually able to discuss taxes and tax planning with their clients due to compliance reasons or even lack of expertise. This is most common for non-independent financial advisors who work for the big brand names you see on television. Instead, they refer their investment clients to their CPAs (who often refer the question back to the financial advisor in a never-ending cycle of frustration).

Yet, there is often massive and quantifiable value to be uncovered via a tax-conscious approach to your retirement plan. 

In fact, ignoring taxes altogether in retirement is a great way to leave dollars on the table, reduce lifetime spending, and increase the risk that you will outlive your money (instead of the other way around).To that end, we urge you to have your financial plan reviewed by a holistic financial planner with expertise in guiding retirees through a tax-conscious retirement. To help get you started on the path toward a tax-savvy retirement, here's a list of some impactful retirement tax planning strategies to consider as you near retirement: 

Create a Tax-Conscious Withdrawal Strategy

Your withdrawal strategy defines how much money you will withdraw monthly from your retirement accounts to fund your retirement expenses. For individuals who have done the hard work of creating tax diversification, one of the most important decisions to make is which retirement account to withdraw from in any given year. 

Be tax savvy when deciding which investment account to withdraw from in retirement. 

For example, withdrawals from a Roth IRA are not taxed. Withdrawals from a Traditional IRA or other similar 'deferred' account are taxed at your personal income tax rate. Withdrawals from taxable accounts may or may not have taxable implications depending on which asset you sell and whether you realize capital gains upon selling. More, short-term ang long-term capital gains are taxed differently.

Having a plan for which account to withdraw from and when is an incredibly important aspect of any solid retirement plan. 

Consider Roth Conversions Both Prior To and During Retirement

Roth Conversions can be an incredible tool for lowering your long-term tax bill when used wisely and proactively. The idea is simple: Contribute to deferred-style accounts in your high-earning years when your marginal tax rate is likely at its highest (barring tax code changes). Then, in lower-income years or years with zero taxable income, convert your Traditional or deferred accounts to a Roth IRA and pay taxes on the conversion at a lower marginal rate.

Importantly, once the money is in the Roth IRA, any growth, income, or withdrawals are all tax-free. 

Roth conversions can be done prior to or during retirement and are, for many individuals, an incredibly effective tool for lowering their lifetime tax bill. Roth IRAs are not subjected to the same Required Minimum Distribution rules as deferred accounts. Moreover, Roth IRAs are incredible accounts for legacy goals because when your heirs inherit a Roth IRA, the inheritor does not have to pay taxes on any withdrawals. 

Qualified Charitable Distributions (QCD's)

Qualified Charitable Distributions (also known as QCDs) are for individuals aged 70 ½ and allow you to make charitable contributions directly from your pre-tax IRA. What would typically be a taxable distribution is made tax-free since it is going directly to a 501(c)(3) organization, effectively giving you a deduction that you might not otherwise be able to receive. This can be hugely beneficial to taxpayers who need to make Required Minimum Distributions (RMD), which now start at age 73 (and previously started at age 70 ½). The amount distributed to charity counts toward your annual RMD, although Qualified Charitable Distributions are subject to a limit of $105,000 per year.   

Qualified Charitable Distributions have two main benefits: 

  1. Reduce your Adjusted Gross Income (AGI): Unlike most pre-tax IRA distributions, the amount distributed for a QCD is not included in the individual’s Adjusted Gross Income (AGI) for the year. Traditional IRA withdrawals are normally taxed as ordinary income, which can cause unwanted tax complications such as negatively affecting Social Security benefits or Medicare premiums. 
  2. Receive a charitable deduction and the new, higher standard deduction: Using a qualified charitable distribution maintains a dollar-for-dollar benefit for charitable giving while allowing the individual still to get the benefit of the higher standard deduction. Since many retirees have paid off their mortgage in full, they are often unable to itemize deductions due to the higher standard deduction negating the tax benefits of charitable giving. Using a QCD allows these retirees the opportunity to both get the charitable deduction (via the reduction in income) and still benefit from the higher standard deduction. 

QCDs can meaningfully impact after-tax cash flow and are another great strategy to consider in retirement to reduce one's annual tax bill. 

Be Proactive with Tax Loss Harvesting

Tax Loss Harvesting is a great strategy for reducing your taxable income in retirement. Basically, tax loss harvesting is implemented by taking advantage of any unrealized losses in positions in your taxable accounts. You can sell the asset at a loss, immediately rebuy another asset in your account to stay invested, and then use that loss to offset taxable gains elsewhere or up or up to $3,000 of taxable income on your annual tax return. Importantly, losses can be carried forward on your tax return if they are not used up in the initial year. Watch out for wash sale rules when rebuying 
Tax gain harvesting is another strategy to consider. Similar to the timing of Roth Conversions, you harvest gains (sell winners) in years where your taxable income is lower than it will be in future years. In some scenarios, tax gain harvesting can be a great way to sell assets at a gain while still paying no income tax. For example, the long-term capital gains rate is 0% for married filing jointly taxpayers on up to $94,050 of income in 2024. Individual filers' capital gains rate is 0% on up to $47,025 of personal income in 2024. Incredible! 

Interesting in planning for a tax-conscious retirement with our team of CERTIFIED FINANCIAL PLANNER™ professionals? Schedule a call with our team below, and we'll happily give you a second opinion on your retirement plan:  

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