There are certain moments in life when tax planning becomes especially important. If you’re in your 50s or 60s, this is one of them.
Retirement isn’t simply the end of a career; it’s a transition to a new way of generating income.
While many people spend decades building their retirement savings, fewer spend time planning how to withdraw the assets tax-efficiently.
This is important because:
- Your tax return may look very different in retirement.
- Your sources of income begin to change.
- You may have years when you’re temporarily in a lower tax bracket.
These changes can create valuable financial planning opportunities.
Here are three key retirement tax planning opportunities, followed by a short roundup of other areas to optimize.
#1—Roth Conversions
A Roth conversion allows you to move money from a traditional IRA into a Roth IRA.
You pay income taxes on the amount you convert today, but qualified withdrawals from the Roth IRA are tax-free in the future.
Key benefits include:
- Creating a source of tax-free retirement income, enabling greater flexibility when managing withdrawals.
- Filling up a lower tax bracket. (Converting just enough money to maximize today’s low tax rate without pushing yourself into a higher one.)
- Paying taxes now to reduce taxes later.
Also, a Roth conversion typically creates a more tax-efficient inheritance for your heirs.
You pay the taxes today, allowing your beneficiaries to receive tax-free withdrawals from an inherited Roth IRA, assuming the Roth rules are met. By comparison, withdrawals from an inherited traditional IRA or 401(k) are generally taxable as ordinary income.1
Roth conversions need to be modeled extensively, since they can increase your modified adjusted gross income. We use two software tools for Roth conversion planning, including Holistiplan and Income Lab.
Reach out if you’d like to model some scenarios.
Keep in mind, Roth conversions can often take years to reach a breakeven point.
#2—Social Security Claiming Timing
Many people think the Social Security decision comes down to one question: Should I claim early or wait?
This is important.
However, the timing of your benefits can also impact your tax strategy.
For Example:
Imagine you retire at age 64 but don’t plan to claim Social Security until age 70.
During these six years, you may have little taxable income because you’ve stopped working, haven’t started receiving Social Security and Required Minimum Distributions (RMDs) haven’t begun.
These lower-income years may create opportunities to:
- Complete Roth conversions while you’re in a lower tax bracket.
- Withdraw money from tax-deferred retirement accounts at lower tax rates.
- Reposition investments before additional retirement income begins.
The key isn’t simply deciding when to claim Social Security. It’s coordinating the decision with the rest of your retirement income plan.
#3—Tax Diversification & Tax–Efficient Withdrawals
A well-diversified portfolio can help manage investment risk, while a tax-diversified portfolio can increase flexibility when it’s time to generate retirement income.
Ideally, your retirement savings are spread across three tax buckets:
- Taxable (brokerage accounts)
- Tax-deferred (traditional IRAs and 401(k)s)
- Tax-free (Roth IRAs and 401(k)s)
Having assets in each of these buckets gives you more choices when generating retirement income. Instead of withdrawing from the same account every year, you can select the accounts that best fit your tax situation.
For Example:
If you realize a large capital gain (e.g., selling an investment property or appreciated investments) you may choose to rely more on tax-free Roth IRA withdrawals for this particular year rather than taking additional taxable distributions from a traditional IRA.
Over time, this flexibility may help make your retirement income strategy more tax efficient.
Related Post: Stress-Free Retirement Spending: The Investment Bucket Strategy
While Roth conversions, Social Security and tax buckets form the foundation of a solid plan, a truly tax-efficient retirement requires watching the fine print, too.
More Opportunities for Lifetime Tax Savings
Finding meaningful savings comes from looking at the whole picture and making small, coordinated moves over time.
Here are nine additional tax-planning opportunities we monitor with you to help minimize your lifetime tax liability:
Medicare IRMAA Surcharges: Manage your income levels to avoid triggering higher Medicare Part B and Part D premiums. Before recognizing a large gain or completing a Roth conversion, look at whether it could push you into a higher IRMAA bracket. Here’s our chart reflecting Medicare Parts B and D income-related adjustments.
Related Post: Medicare: The $1 Mistake that Costs $3,500.
Capital Gains Planning: Review your portfolio for opportunities to strategically harvest tax losses or realize gains to offset future liabilities.
Estate Planning & Lifetime Gifting: Consider whether it makes sense to transfer assets to children or grandchildren now to complement your broader estate and tax plan.
Stock Options & Concentrated Stock: Develop a multi-year plan for diversifying single-stock positions to manage investment risk and tax challenges.
Health Savings Accounts (HSAs): Continue funding your HSA if eligible, since it’s one of the most tax-efficient ways to save for future healthcare expenses.
Catch-Up Contributions: Maximize available catch-up contributions if you’re age 50 or older, and strategically split them between traditional and Roth accounts when applicable. See our chart for contribution limits.
Charitable Giving: Utilize Qualified Charitable Distributions (QCDs) or donate appreciated securities instead of cash to maximize the tax efficiency of your giving.
Required Minimum Distributions (RMDs): Plan ahead for future mandatory distributions well before they begin to help reduce their impact on your ordinary income.
Spouse Protection Planning: Anticipate the transition from a joint to a single tax return, which can increase tax obligations (widow’s tax) since a survivor no longer has the larger joint deduction. Maximizing Social Security to secure a higher survivor benefit, combined with early Roth conversions to reduce future taxable distributions, can help protect a surviving partner’s income down the road.
RESOURCE: Fidelity has written an excellent article explaining 4 Retirement Tax Surprises, including shifting tax brackets, surcharges, the widow’s penalty and fewer deductions.2
–David Bunker, Financial Advisor & Licensed Fiduciary
Before You Go
Get help optimizing your retirement income. Download our FREE “Prolonging Retirement Income” checklist.
Also, receive help retiring to the life you want, schedule a complimentary financial planning consultation.
This communication was prepared with financial writer Sharron Senter’s assistance, based on interviews with David Bunker, a financial advisor and licensed fiduciary.
Sources:
1) IRS.gov, Retirement topics-beneficiary, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary
2) Fidelity.com, 4 retirement tax surprises, https://www.fidelity.com/learning-center/wealth-management-insights/avoid-tax-surprises-in-retirement
Bay Colony Advisors, DBA Windsor Wealth Management, is not a Certified Public Accountant and does not provide tax, legal, or accounting advice. Any tax-related information provided is for general informational purposes only and should not be construed as legal or tax advice. Each individual’s tax situation is unique, and you should consult with your own tax, financial, or legal advisors before making any decisions. We strongly recommend seeking the advice of a qualified CPA or other professional for personalized tax advice.
