By Tricia Lepofsky, ChFC®
If you find yourself dreaming about retirement, chances are high that taxes aren’t the first thing that comes to mind. But here’s a nugget of wisdom: Giving attention to your tax situation can make a big difference in your financial strategy. It’s simple math—less tax equals more money in your pocket during retirement.
Instead of waiting until tax time to plan, consider giving it your attention year-round. If you’re keen on optimizing your golden years, read the following 5 tax strategies to reduce your tax burden and boost your savings to maximize your retirement.
1. Limit Your Exposure to the 3.8% Medicare Surcharge Tax
There is a 3.8% Medicare surcharge tax (1) that applies to net investment income for singles with a modified adjusted gross income (MAGI) of over $200,000 and couples with a MAGI over $250,000. The MAGI is adjusted gross income with some deductions added back in, such as tax-free foreign income, IRA contributions, and student loan interest. The surcharge tax is due on the smaller of net investment income (which includes interest, dividends, annuities, gains, passive income, and royalties) or the excess of MAGI over the thresholds.
If your MAGI is near or above the thresholds, there are steps you can take to limit your exposure. First, you will want to review the tax efficiency of your investment holdings. It may be worthwhile to move less efficient investments into tax-deferred accounts and capitalize on tax-loss harvesting. Other moves you can make include investing in municipal bonds, which have tax-free interest, and taking capital losses to offset gains. Installment sales can spread out large gains and minimize your adjusted gross income, and real estate like-kind exchanges can also defer gains and their taxability.
2. Utilize Roth IRA Conversions
Distributions from Roth IRAs are tax-free, so they are a great tool to have in retirement. However, many people cannot contribute directly to a Roth IRA because of income limitations. (2) Instead, you have to convert traditional IRA funds to a Roth account by paying the related income taxes. You can take advantage of low-income years, such as when you have stopped working but are not yet collecting Social Security, to convert your funds to a Roth IRA so you’ll have tax-free income later. It is important to be mindful of tax brackets when you do conversions so you don’t inadvertently push yourself into higher tax rates.
3. Take Advantage of the 0% Rate on Long-Term Capital Gains
If the Medicare surcharge tax is irrelevant to you because your income is lower, then you may be able to take advantage of the 0% long-term capital gains rate. Profits on the sales of assets owned over a year are tax-free if your income is below $47,025 for singles or $94,050 for married couples filing jointly. Once you exceed those thresholds, long-term capital gains are taxed at 15% until your income gets above $518,900 for singles or $583,750 for couples, at which point the tax rate goes up to 20%. (3)
Claiming more deductions or making deductible IRA contributions can help keep your income within the 0% capital gains tax range while also providing their usual tax benefits. However, you will want to be strategic about taking tax-free gains as they can raise your adjusted gross income and affect the taxability of your Social Security benefits. Also, taking those gains may incur state tax liabilities as well.
4. Be Strategic About Inherited IRAs
At the beginning of 2020, the laws surrounding IRAs inherited by non-spouses changed. You no longer have to take out a specific amount of money from the account each year, but you do have to empty the account within 10 years. If you fail to be strategic about withdrawals, you could be forced to empty the entire account at once with 10 years’ worth of growth. The problem with that is that it would greatly increase your taxable income for the year, pushing you into higher tax brackets and subjecting you to added taxes, like the Medicare surcharge tax. If you inherit an IRA from someone other than your spouse, you need to be strategic about your withdrawals and time them so as to limit your tax liability.
5. Donate Effectively
If you are charitably inclined, one of the best ways to save on taxes is through donations. You can get a tax deduction on donations up to 60% of your adjusted gross income. (4) If you have appreciated assets, you can get an even greater tax break. When you donate an appreciated asset that you have owned for over a year, such as stocks, to a charity, you do not have to pay capital gains taxes on the appreciation, but you still get to claim the full value for your deduction. This allows you to avoid the capital gains tax altogether. If your assets have declined in value, it is best to sell them yourself and donate the proceeds so you can claim the loss when filing your taxes.
Another strategy to consider is the use of a charitable lead annuity trust or a donor-advised fund, which allow you to take an up-front write-off that can help offset other income, such as from a Roth IRA conversion or withdrawal from an inherited IRA.
How We Can Help You Save
Ready to ease the tax load on your retirement? While there are many steps you can take, the world of taxes can be a complex maze with many factors to consider. But don’t stress; you don’t have to navigate it alone. If you’re eyeing these strategies, we encourage you to team up with a seasoned financial advisor who can help optimize your retirement plan and set you up for success in your golden years.
And if you’re still searching for your go-to advisor yet, let’s chat! Our team at KFA Private Wealth Group is here to help you chart a course toward your ideal retirement. Take that first step by emailing firstname.lastname@example.org or calling 571-327-2222 to schedule an appointment.
Tricia Lepofsky, ChFC®, is a financial advisor at KFA Private Wealth Group, a registered independent advisory firm founded on the premise of providing conflict-free financial and investment advice. With a background in music education and opera, Tricia transitioned to the financial industry to help people understand what their money can do and feel more in control as they work toward their goals. Tricia is known for her attention to detail and her dedication to her clients and their unique financial challenges. She is passionate about building relationships with her clients and partnering with them as they walk through life’s milestones, keeping them accountable and motivated to pursue their goals. While she serves a diverse range of clients, Tricia uses her background of 18 years in the Washington National Opera and Washington Concert Opera to specialize in serving hardworking, intelligent individuals who have a connection to the arts. In her spare time, Tricia loves to travel with her husband, Mark, hike trails along the Potomac River or in the Blue Ridge Mountains, and support former colleagues by attending live performances of operas and musicals. To learn more about Tricia, connect with her on LinkedIn.