Maximize Your Retirement Wealth with Proactive Tax Planning Strategies

Tax planning does not become simpler as you grow older; it can become more intricate. With age comes greater complexity in taxes, presenting more opportunities for proactive tax planning. This can be advantageous in terms of accessing tax deductions and credits.

Taxes often appear more complicated, partly due to the increased income sources you may have. Additionally, you are responsible for managing tax withholdings independently once you retire. Tax complications can also arise concerning Medicare premiums, Social Security, and Required Minimum Distributions.

There is a common belief that taxes are lower during retirement. While this may sound beneficial, ideally, your income should remain the same or even increase compared to when you were working. In this favorable scenario, maintaining your standard of living during retirement may result in higher tax payments.

Tax planning doesn’t end when you retire. Even after leaving the workforce, you can reduce your annual taxes in numerous ways. Various tax-planning strategies can help stretch your retirement income over your lifetime.

Your income level can influence your Medicare premiums. Your premiums may be affected by the income-related monthly adjustment amount (IRMAA) for Medicare Part B and Part D. The premiums you pay each year are determined by the tax returns you filed two years ago. Therefore, proactive tax planning to minimize taxable income can have the additional benefit of reducing your Medicare premiums.

It is important to plan to avoid inadvertently increasing your Medicare premiums by withdrawing extra funds from a retirement account or realizing capital gains. IRMAA surcharges operate as a cliff rather than a gradual phase-in.

Donating your Required Minimum Distributions directly to charity is an option once you reach the age of 73. This qualifies as a charitable contribution and helps prevent your RMD from increasing taxable income.

Running a business or engaging in a side hustle has become part of the new retirement lifestyle. Many retirees have some form of earned income, which opens up various tax-planning strategies. Even earning a modest amount from a side gig can be classified as business income, allowing for deductions such as health insurance premiums, home office expenses, and other tax benefits available to small business owners.

Having self-employment income also provides opportunities to contribute to a wider range of retirement plans. While you may feel that you are already retired and don’t want to save more for retirement, contributing to a SEP IRA, Solo 401(k), or Cash Balance Plan can help lower your household income if your spouse is still working. Additionally, setting up a Roth 401(k) could enable you to grow more tax-free retirement income.

It’s crucial to remember that your Social Security benefits may be subject to taxes. Many retirees believe that taxes cease once they retire. Unfortunately, even low-income individuals often owe taxes on their retirement income, primarily Social Security. Taxation of Social Security benefits starts at just $25,000. 

Although benefits are taxed at slightly lower rates than other income types, taxes are still applicable. Strategically planning IRA withdrawals can be beneficial if you approach the Social Security taxability threshold. You can reduce taxes on your Social Security benefits by adjusting the timing and amount of withdrawals.

The state you choose to live in during retirement will affect the income taxes you owe. Different states have varying approaches to taxing different types of retirement income, and some states do not tax certain retirement income, which extends beyond states without an income tax.

Tax loss harvesting can be a valuable strategy to offset your retirement tax burden. If you have accumulated significant capital gains from your investments over time, you may be required to realize some gains once you retire. Implementing tax loss harvesting techniques can help minimize your annual tax liability. Consult with a tax-planning financial planner to develop a strategy enabling you to pay the least taxes over your lifetime.

Sometimes, paying more taxes in the current year can be advantageous. While it may seem counterintuitive, it can prevent a substantial tax burden in the future. This is evident in the choice between a Roth IRA and a traditional IRA. Instead of depleting your low-tax retirement assets first, such as brokerage accounts and Roth IRAs, having a diversified retirement income plan is beneficial. This includes a combination of tax-free income (e.g., Roth IRA), taxable income (e.g., traditional IRA), and income subject to capital gains (e.g., brokerage account). Depending on your retirement assets and income needs, strategically withdrawing from each source can help you stay in the lowest tax brackets possible. It also minimizes the taxable portion of your Social Security benefits and reduces or eliminates IRMAA surcharges, which would otherwise increase your Medicare premiums. While this approach may slightly increase your current income taxes, it can reduce your overall lifetime tax burden.

Let’s put it this way: Would you prefer to pay taxes annually in the 10% to 12% tax brackets or find yourself in the 32%, 34%, or 37% tax brackets later in life? By proactively planning to minimize taxes during retirement, you decrease the risk of running out of money as you age, and it also allows you to maximize your take-home pay each year and minimize your lifetime tax bill. Striving for a financially secure and fulfilling retirement involves taking steps to minimize taxes, as few people derive joy from paying excessive taxes.