Whether you’re just easing out of the workforce or you’ve been in retirement for a few years, making the right financial moves is critical. Whether you’re working with an advisor or handling your own finances, there is one important goal during retirement – to protect your wealth from unnecessary taxes.
In many cases, there are ways to avoid owing more taxes, but usually, this requires proactive action beyond tax season. Here are four suggestions you can utilize throughout the year to help minimize your tax obligations in retirement.
Tip #1: Take Your Required Minimum Distributions (RMDs)
An RMD is an amount that must be withdrawn from your retirement account once you reach age 73. These required withdrawals apply to employer-sponsored retirement plans and traditional IRAs, but not to Roth IRAs or Roth 401(k) accounts while the account owner is still alive.
While RMDs are mandatory, there may be planning opportunities before they begin. Many retirees experience lower-income years after leaving full-time work but before Social Security benefits and RMDs start. Taking strategic IRA distributions during this window, when managed carefully, can help reduce the size of future RMDs and potentially lower overall lifetime taxes.
Although some custodians calculate RMD amounts, the responsibility ultimately rests with you. If the correct amount is not withdrawn, the shortfall may be subject to a 25% penalty, or 10% if corrected promptly. This is why proactive planning, both before and after RMDs begin, plays an important role in a well-coordinated retirement strategy.
Tip #2: Manage Your Income Combinations
As a retiree, a portion of your income will likely come from Social Security. Not all of your benefits are taxable, and there are ways to minimize or, at times, eliminate taxes on your Social Security benefits.
If half of your Social Security benefits in addition to your other income is higher than the base amount for your status, your benefits will be taxable. By strategically managing all your income sources (such as pension payments, dividends, or part-time jobs), it’s possible to lower the portion of benefits that will be taxed. Rules regarding Social Security income taxes also vary from state to state, so always check with your state regulations to determine the best solution for you.
In addition, higher income in retirement can increase Medicare costs. Medicare uses income from two years prior to determine whether retirees are subject to Income-Related Monthly Adjustment Amounts (IRMAA), which can raise Part B and Part D premiums. One-time income events, such as large IRA withdrawals or Roth conversions, can unintentionally trigger these surcharges. Coordinating income sources thoughtfully can help reduce both taxes and Medicare premiums over time.
Tip #3: Figure Out Whether You Need to Pay Quarterly Taxes (and When It May Make Sense)
If taxes are not being withheld automatically from your income, you may be required to make estimated quarterly tax payments. Generally, estimated payments are required if you expect to owe $1,000 or more in taxes and your withholding and refundable credits are either less than 90% of the tax owed for the current year or less than 100% of the tax shown on your prior year’s return.
Even if you are not required to pay quarterly taxes, some individuals choose to do so to spread payments evenly throughout the year and avoid a large tax bill at filing time. To avoid penalties, payments should be made on time and in sufficient amounts to meet IRS safe harbor rules. Missing a payment or underpaying can result in penalties and interest, which is why planning ahead and monitoring income throughout the year is important.
The IRS expects payments periodically through the year, typically on April 15, June 15, September 15, and January 15 of the following year.
Tip #4: If You’re Moving to a New State, Get to Know Its Tax Laws
If you’re relocating to a new state during retirement, consider the impact of the move on your financial situation, as tax laws vary according to the state. For example, some states, like Florida and New Hampshire, don’t tax on income or only tax on dividends and interest. On the other hand, they may have higher property taxes. For example, New Hampshire’s property taxes are high compared to the rest of the country.
In many cases, retirees are working with a fixed amount of wealth to last throughout retirement, which is why taking the right financial steps is essential. By working with an advisor and keeping these four tips in mind during the year, you can make sure you’re not paying more than you need to.
If you’re managing things on your own, or questioning whether your current advisor is as proactive and aligned as you’d like, the beginning of a new year can be a meaningful time to explore what a more thoughtful partnership might look like.
If you’d like to learn more about how we help families navigate financial decisions with clarity and confidence, we invite you to explore our approach or reach out for a conversation.
