Tax Planning Tips for Retirees

Keep More of Your Money in Retirement (The IRS Already Takes Enough)

You spent decades working, saving, and building up your retirement accounts. Now that you're finally ready to use that money, guess who's waiting with their hand out?

The IRS.

Taxes don't stop when you retire. In fact, if you're not careful, you might end up paying more in taxes during retirement than you did while you were working. And that's just ridiculous.

The good news? With some planning, you can keep a lot more of your hard-earned money and give the IRS a lot less. You just need to understand how retirement income is taxed and make some smart moves.

So let's talk about tax planning for retirees. Not the complicated stuff that only accountants understand. The practical strategies that can actually save you real money.

Understanding How Your Retirement Income Gets Taxed

First, you need to understand that not all retirement income is taxed the same way. This is important because knowing which accounts to draw from and when can save you thousands of dollars.

Traditional IRAs and 401(k)s

Money you withdraw from traditional retirement accounts is taxed as ordinary income. Every dollar you take out gets added to your taxable income for the year, just like a paycheck.

Why? Because you got a tax deduction when you put that money in. The IRS let you skip paying taxes on it back then, but they're going to collect when you take it out. They always get their cut eventually.

Roth IRAs and Roth 401(k)s

Roth accounts work the opposite way. You paid taxes on that money before you put it in. So when you take it out in retirement, as long as you follow the rules, it's tax-free.

This is huge. Tax-free withdrawals in retirement can save you a fortune, especially if tax rates go up in the future.

Social Security

Here's where it gets annoying. Depending on your other income, up to 85% of your Social Security benefits can be taxable.

Yes, you read that right. The government taxes money that the government is paying you. It's as ridiculous as it sounds, but that's how it works.

Whether your benefits are taxed depends on what's called your combined income. That's your adjusted gross income, plus any tax-exempt interest, plus half of your Social Security benefits.

If you're single and your combined income is over $34,000, or married filing jointly and over $44,000, up to 85% of your benefits may be taxable. Below those thresholds, less of your benefits are taxed, and if your income is low enough, none of it is taxed.

Pensions

Pension income is generally taxed as ordinary income, just like traditional IRA withdrawals. If you're lucky enough to have a pension, that monthly check is going to be taxable.

Investment Income

If you have taxable investment accounts, dividends and interest are taxed annually. Capital gains from selling investments are taxed based on how long you held them. Long-term capital gains, meaning you held the investment for more than a year, get preferential tax rates that are usually lower than ordinary income rates.

Understanding these differences is step one. Now let's talk about how to use this knowledge to your advantage.

Strategy 1: Manage Your Tax Bracket

Federal income tax is progressive, which means the more you make, the higher percentage you pay on the top portion of your income. You're not taxed at one flat rate. You're taxed in brackets.

For 2024, a married couple filing jointly pays 10% on the first $23,200 of taxable income, 12% on income between $23,200 and $94,300, and so on up the ladder.

Here's the key insight: you want to manage your income so you don't bump yourself into a higher bracket unnecessarily.

Let's say you're retired and you need $60,000 a year to live on. If you take all $60,000 from your traditional IRA in one big withdrawal, that's all taxable income. But if you pull $30,000 from your traditional IRA and $30,000 from your Roth IRA, only half of it is taxable. You get the same amount of money but pay way less in taxes.

This is called tax diversification. Having money in different types of accounts gives you flexibility to manage your tax bill year to year.

The goal is to fill up the lower tax brackets with taxable income, then use tax-free sources like Roth accounts for the rest. You're getting the money you need while keeping your tax bill as low as possible.

Strategy 2: Time Your Withdrawals Strategically

When you take money out of your retirement accounts can matter just as much as how much you take out.

Here's a scenario. Let's say you retire at 62 but you're going to wait until 70 to claim Social Security. That gives you an eight-year window before Social Security kicks in.

During those eight years, your income might be lower than it will be later when Social Security starts. This could be a great time to do Roth conversions. You convert money from your traditional IRA to a Roth IRA, pay the taxes now while you're in a lower bracket, and then that money grows tax-free forever.

Another strategy: if you have a year where your income is unusually low, maybe you didn't work much or you had some deductions that brought your taxable income down, consider taking more out of your traditional IRA that year. Fill up that lower tax bracket while you can.

On the flip side, if you have a year where your income is unusually high, maybe you sold a property or had a big bonus, lean more heavily on your Roth accounts that year to avoid spiking your tax bill even higher.

Flexibility is power. The more options you have, the better you can manage your taxes.

Strategy 3: Consider Roth Conversions

Speaking of Roth conversions, let's dive into this a little deeper because it's one of the most powerful tax planning tools retirees have.

A Roth conversion is when you move money from a traditional IRA or 401(k) into a Roth IRA. You pay taxes on the amount you convert in the year you do it. But once it's in the Roth, it grows tax-free and you can withdraw it tax-free in the future.

Why would you volunteer to pay taxes now? A few reasons.

First, if you think tax rates are going up in the future, it makes sense to pay taxes now at today's rates rather than later at potentially higher rates.

Second, Roth IRAs don't have Required Minimum Distributions. Traditional IRAs force you to start taking money out at age 73 whether you need it or not. Roth IRAs don't. That gives you more control.

Third, Roth IRAs are great for estate planning. If you're going to leave money to your kids, they'll inherit it tax-free if it's in a Roth. If it's in a traditional IRA, they'll owe taxes on every dollar they withdraw.

The key with Roth conversions is to be strategic. You don't want to convert so much in one year that you spike yourself into a high tax bracket. Instead, convert a little bit each year, filling up the lower brackets without going too high.

This is definitely a conversation to have with your tax advisor and financial planner. Roth conversions can be incredibly valuable, but only if you do them right.

Strategy 4: Be Smart About Required Minimum Distributions

Once you turn 73, the IRS forces you to start taking money out of your traditional IRAs and 401(k)s. These are called Required Minimum Distributions, or RMDs.

The government let you defer taxes for decades. Now they want their money. So they make you take out a certain percentage each year, and you pay taxes on it whether you need the money or not.

Missing your RMD is a big deal. The penalty is 25% of the amount you should have taken out. If you were supposed to withdraw $10,000 and you didn't, you owe the IRS $2,500. Plus you still have to take the withdrawal and pay taxes on it. Ouch.

So what can you do?

Start Taking Withdrawals Before You Have To

If you're in your 60s and your income is relatively low, consider taking money out of your traditional IRA even though you're not required to yet. You'll pay taxes at a lower rate now and reduce the amount that will be subject to RMDs later.

Qualified Charitable Distributions

If you're charitably inclined and you're 70 and a half or older, you can donate up to $105,000 directly from your IRA to a qualified charity. This counts toward your RMD, but it doesn't get added to your taxable income.

So if your RMD is $20,000 and you donate $10,000 through a Qualified Charitable Distribution, you only have to take the other $10,000 as taxable income. You fulfilled your RMD requirement, supported a cause you care about, and lowered your tax bill. That's a win all around.

Delay If You're Still Working

If you're still working at 73 and you're contributing to your employer's 401(k), you can delay RMDs from that specific 401(k) until you actually retire. This only works if you don't own 5% or more of the company, but it's a nice break if it applies to you.

RMDs are a pain, but with some planning, you can minimize the damage.

Strategy 5: Take Advantage of the Standard Deduction

For 2024, the standard deduction for a married couple filing jointly is $29,200. For single filers, it's $14,600. That means the first $29,200 or $14,600 of your income is effectively tax-free.

A lot of retirees don't have enough itemized deductions to beat the standard deduction. Your mortgage might be paid off. Your kids are grown so you're not claiming them anymore. That's fine. Take the standard deduction and use it to your advantage.

Here's the strategy: every year, you can pull that much money out of your traditional IRA without paying any federal income tax on it. You're filling up your standard deduction with taxable income and paying zero tax.

If you're married and your only income is $29,200 from IRA withdrawals, your federal tax bill is zero. You've effectively gotten $29,200 out of your IRA tax-free.

Obviously most retirees need more than that to live on. But understanding this concept helps you think strategically about which accounts to tap and when.

Every dollar you can shelter from taxes is a dollar that stays in your pocket instead of going to the IRS.

Strategy 6: Watch Out for Medicare Surcharges

Here's something that catches a lot of retirees off guard: if your income is too high, you'll pay more for Medicare.

It's called IRMAA, which stands for Income-Related Monthly Adjustment Amount. Basically, if your income two years ago was above certain thresholds, you pay higher premiums for Medicare Part B and Part D.

For 2024, the threshold for married couples filing jointly is $206,000. If your income in 2022 was over that, your Medicare premiums went up. The surcharge can be a few hundred dollars a month or more, depending on how far over the threshold you are.

Why does this matter? Because a big IRA withdrawal or a Roth conversion in the wrong year could push you over the threshold and cost you thousands in higher Medicare premiums two years later.

This is another reason to be strategic about withdrawals and conversions. Spreading them out over multiple years instead of doing one huge withdrawal can help you stay under the IRMAA thresholds.

It's yet another example of how managing your taxable income in retirement isn't just about income taxes. It affects other things too.

Strategy 7: Don't Forget About State Taxes

We've been talking mostly about federal taxes, but don't forget about state taxes.

Here in Virginia, we do tax retirement income, but there are some breaks. If you're 65 or older, you can subtract up to $12,000 of retirement income from your Virginia taxable income. That helps, but it doesn't eliminate state taxes entirely.

Some states don't tax retirement income at all. Others tax it heavily. If you're considering a move in retirement, taxes should absolutely be part of that conversation.

But be careful. Don't move somewhere just to save on taxes if you're going to be miserable there. Quality of life matters more than saving a few thousand bucks a year on taxes.

That said, if you're choosing between two places you'd equally like to live, and one has better tax treatment for retirees, that's worth considering.

Work With Professionals

Here's the thing about tax planning in retirement: it gets complicated fast. The strategies I've outlined here are just the beginning. There are layers and layers of complexity depending on your specific situation.

Do you have a pension? Do you have significant taxable investments? Are you planning to leave money to your kids? Do you own a business? All of these things affect your tax strategy.

This is not something to DIY. Work with a financial advisor who understands retirement tax planning. Work with a CPA or tax professional who can help you implement these strategies correctly.

The money you spend on good advice will pay for itself many times over in tax savings. I've seen people save tens of thousands of dollars with smart tax planning. That's real money that stays in your pocket.

At Iron Eagle Advisors, we help retirees here in Charlottesville navigate these exact issues. Tax planning is a core part of retirement planning, and we make sure our clients aren't leaving money on the table.

The Bottom Line

You worked your whole life to build up your retirement savings. The last thing you want to do is hand over more of it to the IRS than you have to.

Smart tax planning in retirement can save you thousands, sometimes tens of thousands of dollars over the course of your retirement. That's money you can spend on the things that actually matter to you instead of writing checks to Uncle Sam.

The strategies we covered here are just a starting point. Managing your tax bracket, timing your withdrawals, considering Roth conversions, being smart about RMDs, using the standard deduction, watching out for Medicare surcharges, and understanding state taxes.

None of this is rocket science. But it does require attention and planning. The retirees who pay the least in taxes aren't the ones who get lucky. They're the ones who plan ahead.

Don't leave money on the table. Make a plan. Work with professionals. And keep more of what's yours.

Want Help Creating a Tax-Efficient Retirement Plan?

Let's make sure you're not paying more in taxes than you need to. Schedule a free consultation with Iron Eagle Advisors today.