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  • Writer's pictureJoshua Henry

Saving On Taxes In Retirement

Updated: Aug 3, 2022

  • Joshua Henry

  • December 1, 2020

When you plan for retirement and daydream about the next chapter in your life, taxes don’t always come to mind. People usually start thinking about taxes in February, and once their return is filed a month or two later, they put them completely out of mind. However, if you want to minimize your tax liability, it is important to keep taxes in mind year-round. In fact, this is especially important during retirement, when you are drawing down your accounts instead of building them up. So let’s discuss five ways to save on taxes in retirement.

Limit Your Exposure To The 3.8% Medicare Surcharge Tax

There is a 3.8% Medicare surcharge tax that applies to net investment income for singles with a modified adjusted gross income (MAGI) of over $200,000 and couples with a MAGI over $250,000. The MAGI is adjusted gross income with some deductions added back in, such as tax-free foreign income, IRA contributions, and student loan interest. The surcharge tax is due on the smaller of net investment income (which includes interest, dividends, annuities, gains, passive income, and royalties) or the excess of MAGI over the thresholds.

If your MAGI is near or above the thresholds, there are steps that you can take to limit your exposure. First, you will want to review the tax efficiency of your investment holdings. It may be worthwhile to move less efficient investments into tax-deferred accounts and capitalize on tax-loss harvesting. Other moves you can make include investing in municipal bonds whose interest is tax-free and taking capital losses to offset gains. Installment sales can spread out large gains and minimize your adjusted gross income, and real estate like-kind exchanges can also defer gains and their taxability.

Utilize Roth IRA Conversions

Distributions from Roth IRAs are tax-free, so they are a great tool to have in retirement. However, many people cannot contribute directly to a Roth IRA because of income limitations. Instead, you have to convert traditional IRA funds to a Roth account by paying the related income taxes. You can take advantage of low income years, such as when you have stopped working but are not yet collecting Social Security, to convert your funds to a Roth IRA so that you will have tax-free income later. It is important to be mindful of tax brackets when you do conversions so that you don’t inadvertently push yourself into higher tax rates.

Take Advantage Of The 0% Rate On Long-Term Capital Gains

If the Medicare surcharge tax is irrelevant to you because your income is much lower, then you may be able to take advantage of the 0% long-term capital gains rate. Profits on the sales of assets owned over a year are tax-free if your income is below $40,000 for singles or $80,000 for married couples filing jointly. Once you exceed those thresholds, long-term capital gains are taxed at 15% until your income gets above $441,450 for singles or $496,600 for couples, at which point the tax rate is 20%.

Claiming more deductions or making deductible IRA contributions can help to keep your income within the 0% capital gains tax range while also providing their usual tax benefits. However, you will want to be strategic about taking tax-free gains as they can raise your adjusted gross income and affect the taxability of your Social Security benefits. Also, taking those gains may incur state tax liabilities as well.

Be Strategic About Inherited IRAs

At the beginning of the year, the laws surrounding IRAs inherited by non-spouses changed. You no longer have to take out a specific amount of money from the account each year, but you do have to empty the account within 10 years. If you fail to be strategic about withdrawals, you could be forced to empty the entire account at once with 10 years’ worth of growth. The problem with that is that it would greatly increase your taxable income for the year, pushing you into higher tax brackets and subjecting you to added taxes, like the Medicare surcharge tax. If you inherit an IRA from someone other than your spouse, you need to be strategic about your withdrawals and time them so as to limit your tax liability.

Donate Effectively

If you are charitably inclined, one of the best ways to save on taxes is through donations. You can get a tax deduction on donations up to 60% of your adjusted gross income. If you have appreciated assets, you can get an even greater tax break. When you donate an appreciated asset that you have owned for over a year, such as stocks, to a charity, you do not have to pay capital gains taxes on the appreciation, but you still get to claim the full value for your deduction. This allows you to avoid the capital gains tax altogether. If your assets have declined in value, it is best to sell them yourself and donate the proceeds so that you can claim the loss when filing your taxes.

How We Can Help

There are steps that you can take to minimize your tax burden in retirement. However, as with most tax-related things, many different factors come into play and must be considered in order to execute these strategies properly. But don’t worry; you don’t have to walk through this process alone. If you are considering these strategies, partner with an experienced financial advisor to help you navigate all of the details so you can have confidence in your retirement plan.

If you don’t already have a trusted advisor, I would love to have a conversation with you to see how our team at Meridian Financial Advisory may be able to help. You can schedule an introductory phone call using our online calendar or reach out to us at (413) 949-6574 or I look forward to speaking with you!

About Joshua

Joshua Henry is the founder and Managing Principal of Meridian Financial Advisory, an independent, fee-based wealth management company located in South Carolina, serving people locally and across the country. Meridian focuses on providing wealth management solutions primarily to affluent individuals over age 50 and their families. Joshua is passionate about helping people have a better life by designing and implementing customized financial plans that bring clarity and confidence. Joshua is a CERTIFIED FINANCIAL PLANNER™(CFP®), a Certified Investment Management Analyst® (CIMA®) Professional, and earned a Bachelor of Arts degree in Political Science from Cedarville University and a Master of Business Administration degree with a concentration in Corporate Finance from Salve Regina University. The courses for the Corporate Finance concentration were taken from the Kelley School of Business at Indiana University. He has held workshops on Social Security Claiming Strategies, IRA Planning, and Career Coaching for Executives in between jobs. Josh has also taught finance at the university level. When he’s not working, Josh teaches adult Sunday School at his church in Pawley Island, SC. He enjoys traveling, reading, and time with his family. To learn more about Josh, connect with him on LinkedIn.

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