Posted by Thomas G Kinsella, ATP

Proven Tips to Reduce Your Taxes in Retirement

Proven Tips to Reduce Your Taxes in Retirement

Obviously, it is good to save early for retirement as one will qualify for more benefits, but one also needs to prepare for taxes, when retired. 

Here are some proven tips to reduce money when retired:

Leverage the Benefit of Tax Diversification 

The idea of tax diversification is to reduce the entire amount you pay as tax alongside the timing. With the principle of diversifying investment across various assets, one can also diversify multiple taxes. With this, there will be flexibility if there are changes in the tax laws. 

For tax diversification, you need to know how a taxable account differs from a tax-free and a tax-deferred account. 

Tax-deferred vehicles: With this, you can delay taxes on investment gains and generate more gain in time using tax-deferred growth that compounds. With some tax-deferred channels, you can contribute pretax dollars, which will bring down your tax bill, helping to increase saving. Ordinary income rate will apply to your withdrawal after retirement, although both income and taxes when retired are usually lower. 

Tax-free vehicles: You fund this with the after-tax dollar, which means tax payment follows the contribution. The bright side is that your investment will grow with tax, and you can also withdraw without bothering on taxes.

Taxable Accounts: the sale of your investment will warrant tax payment on the gains. If you hold the asset less than a year, you will be taxed at the short-term capital gains rate, while the ones held for more than a year will be taxed at the long-term gains rate. 

Know about Assets 

Tax impact differs for all investments. Some investments are pretty tax-efficient compared to others, which depends on the rate: lower or higher. You can reduce the effects of tax and improve return by leveraging on the asset location. This can result in substantial tax savings for all, especially people in the higher tax bracket. 

What should you include in a taxable account: Consider tax-efficient investments like ETFs, index funds, and hold in a taxable account.

What should you keep in a tax-free account: consider investments that are not tax-efficient, like fixed income, liquid alternatives, REITS, in a tax-free account. It will preserve your gain without the tax burden. 

Other Accounts: use investments that are low costs for variable annuities that are low cost

Understand How Retirement Savings Account Differs 

Retirement savings accounts differ for long term savers alongside qualified plans that are beneficial in terms of taxes. They differ in various ways, like tax treatment of withdrawal and contributions and the account limit. 

With the SECURE Act, you can contribute to this account after 70.5 years, provided you meet other requirements. There are cases in which you will have to note how the required minimum distribution affects. Here are some tax-advantaged accounts that are pretty popular:

401(k): These are sponsored by employers and tax-deferred in which the money you contribute is not taxed. Whatever you withdraw will be subjected to the ordinary income tax 

Roth 401(k). These are also employer-sponsored tax-free plans with the same contribution limit as traditional 401(k). The money you use to fund a Roth 401(k) is already taxed, which means you can withdraw without penalties or taxes provided you are 59.5, and you have held the money for five years at least. Unlike Roth IRAs, 401(k)s does not have any income limit. 

Roth IRAs: these are tax-free accounts that can be funded with after-tax dollars, consequently making the withdrawal tax-free when retired. People who learn a lot will likely have their contribution limit capped or eliminated based on the specified limit put out by Uncle Sam. 

IRAs: also known as individual retirement accounts, are tax-deferred, which means that you will pay tax at the ordinary income rate if you withdraw at retirement. There is the opportunity to contribute pretax dollars in 2020, rising to $6,000. While there might be a tax deduction on the contribution, a workplace retirement plan affects how your deduction will be eliminated or reduced.



Thomas G Kinsella, ATP
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