Sometimes it pays to go against conventional wisdom. Here are two ways to possibly reduce taxes in retirement while extending the life of your nest egg by being smart about which accounts you tap first.
One of the challenges we face in retirement is finding the most advantageous way to draw down savings while minimizing taxes.
Many people have investments in a variety of accounts that have different tax characteristics. These can include traditional IRAs or 401(k)s, Roth IRAs and taxable brokerage accounts. The conventional wisdom is to withdraw from taxable accounts first; followed by tax-deferred accounts; and, finally, Roth assets. This approach affords your tax-advantaged accounts more time to grow tax-deferred — but could also present you with more taxable income in some years than others. As your tax rate is dependent on your income, this could mean more taxes in those high-income years than you originally anticipated.
People with relatively modest incomes may think it best to follow the conventional model. After all, you may pay little or no taxes at first. However, once the taxable accounts are exhausted, you may end up paying a higher tax rate because you are generating more taxable income from tax-deferred account withdrawals.
Instead, consider using your low tax bracket strategically by consistently “filling up” that bracket with ordinary income from tax-deferred account distributions, such as your traditional IRA. If you need more than these withdrawals to support your lifestyle, you can sell taxable account investments, then take money from Roth accounts. This idea isn’t new, but following the Tax Cuts and Jobs Act of 2017, more people may be able to limit their incomes to match their deductions — thus paying zero taxes — or stay within a low bracket.
As you approach retirement, keep in mind:
-Taxes are complicated, so you will probably want to consult with a tax adviser or financial planner for help implementing these strategies.
-Roth conversions are also an option, but our research indicates they are usually better suited for people focused on leaving an estate.
–Tax diversification — having assets in multiple types of accounts — can improve your flexibility in retirement. In both examples above, having some Roth assets is key to implementing the strategy.
With a little planning and a variety of accounts in your portfolio, you can save on taxes and better sustain your retirement lifestyle.
If you or your clients have any tax issues or problems with the IRS/State or other federal tax problems, please feel free to contact me directly at (909) 570-1103 or by email at Carlos@HealthcareTaxadvisor.com
Carlos Samaniego, EA
Enrolled Agent
Licensed by The Department of Treasury to represent taxpayers
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Redlands, CA 92374
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