Don’t Let Your Retirement Savings Get the (T)ax

Sean HarrisIncome, Investment, Planning, Retirement, Savings

Contribute. Contribute. Contribute. For those with limited knowledge of retirement planning, this is the conventional wisdom. And it is, in fact, wise to contribute early and often to your retirement account (or multiple accounts, if you possess a bit of financial savvy). For most people, though, too much of the emphasis is on accumulating capital in a 401k or IRA account and there’s little consideration for the preservation and distribution phases of their retirement strategy. “Preservation and distribution phases?” you ask? Well, at least you’re in the right place.

One of the most important pieces of your retirement strategy involves mitigating the impact of taxation on your various investments in order to retain as much of your hard-earned savings as possible. Here are five things you can do to make sure your money stays with you through retirement.

Use Required Minimum Distributions (RMDs) to your advantage

When you turn 70 ½, the IRS requires that you begin taking disbursements from your IRA, whether you need it or not, so they can soak up that good old tax revenue. When that time comes, be sure to include RMDs as part of your planned income to avoid an additional tax burden, and ensure that the distribution phase of your retirement strategy is as tax efficient as possible.

Avoid higher taxes on short-term capital gains
As you may already know, short-term capital gains are taxed at a higher rate than long term capital gains so, ideally, you want to hold on to your investments for at least a year. But, you can conduct short-term trades in your IRA, allowing any gains to grow tax deferred. Any distributions taken from that account in the future will be taxed at the same rate, avoiding additional tax liability. It’s also best not to unload investments if doing so would mean a higher tax rate for the year.

Don’t pay tax on income you don’t need

If you have multiple income streams while collecting Social Security, you receive a penalty in the form of higher taxes on the Social Security you’re paid. Once you begin collecting Social Security, be careful to only draw from your tax-deferred investments the money you need (and are willing to be taxed on) so the rest can continue to grow tax-deferred.

Reduce taxes owed by utilizing Roth conversions wisely

Roth conversions can significantly reduce the taxes you owe on money earned in your tax-deferred IRA. Since Roth conversions are counted as taxable income, you should closely monitor your yearly income so that the money you convert doesn’t bump you up into the next tax bracket.

Beware the tax bomb on inherited IRAs

If you inherit an IRA, you could lose up to 40 percent of that money as taxable income if you take the entire balance in a single distribution. Instead, you should elect to begin taking Required Minimum Distributions; they will be lower because they are calculated based on your age. That way, the remainder of the account can continue to grow tax deferred.

Clearly, retirement planning is much more than just dropping money into an account and (ideally) watching it grow. A comprehensive strategy for retirement is a moving target that needs to be monitored throughout your life. Any one of the strategies outlined above can be effective ways to minimize the amount of money you lose to Uncle Sam. Unfortunately, the financial landscape is ever-changing, and you should review your approach regularly to stay on track. Always seek the advice of a professional when considering investment strategies. Otherwise, the tax man may be the least of your worries. Get in touch with us to learn more. We’d love to help!