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7 Important Tax Tips Retirees Should Know


ax strategy is an important consideration in the retirement planning process. The average American pays roughly $10,500 per year in combined local, state, and federal income taxes. Retirees generally have less taxable income, which means they pay less in income taxes, but they also must be strategic with all financial decisions to reduce their tax expenditure and maximize their disposable income.

Below is a look at six ways retirees can lessen their annual tax burden and keep more of their money for themselves and their family.

Keep Contributing to an IRA or 401(k)

Did you know that you can keep contributing to an IRA after you’ve stopped working? If you have retired, but your spouse still works, you can still contribute to a Roth IRA. You can also keep contributing to a Roth IRA if you’re working part-time. Roth IRA contributions are made on an after-tax basis, so they will not reduce your taxable income, but they will help your account grow.

Many retirees need to continue working part-time to supplement their retirement savings and Social Security. Any earnings that aren't needed to pay monthly bills should be allocated to an IRA, specifically a Roth IRA. There is no age limit for making contributions to a Roth IRA, whereas you can only contribute to a traditional IRA if you're younger than 70.5 years old.

There are several other benefits to saving money in a Roth IRA when you're retired, most notably to reduce the tax burden on your future withdrawals, and on your children and heirs. Designated beneficiaries of inherited Roth IRA accounts can make tax-free withdrawals as long as they abide by IRS rules.

Gifting Stocks

Making charitable donations is an effective way to reduce taxes in retirement, but retirees should be strategic in their philanthropy. Gifting appreciated stocks as opposed to selling them and giving the cash to charities can have substantial short- and long-term tax benefits. For instance, imagine you had stocks valued at $400,000 with an original investment of $250,000. By selling those assets, you'll be forced to pay taxes, likely over several years. If you donated the securities to a nonprofit, you'll not only avoid paying taxes, but you also may be able to deduct the entire amount of the appreciated assets on your return.

Similar to Roth IRAs, gifting stocks is also a great way to lessen the tax burden for your heirs and avoid paying capital gains taxes in retirement. The IRS allows individuals to give as much as $17,000 in stock to as many recipients as they wish per year.

Move to a State with Lower Taxes

The state where you live has a major impact on how much money you can expect to pay in taxes. Florida is a popular retirement destination, and not just for its warm weather and abundance of retirement villages. Florida is one of eight states that doesn't have an income tax, allowing retirees working part-time to save more of their earnings. Moreover, there's no state taxes for pension or Social Security income. Alaska, Nevada, Tennessee, South Dakota, Texas, Wyoming, and Washington also have no personal income tax.

According to the Tax Foundation, California has the highest income tax burden in the country at 13.3 percent. However, retirees should also consider property and sales taxes. There are five states, including Oregon and Montana, that don't have a sales tax, while Louisiana is among the states with the lowest property taxes. Retirees should take into account a state's entire tax structure when deciding where to live to maximize their earnings and savings, and cash flows.

Schedule Quarterly Tax Payments

Unless you were self-employed during your working years, taxes would have been automatically withdrawn from your paycheck to lessen the burden when filing annual income taxes by the April deadline. However, you're responsible for making regular income tax payments in retirement. These payments likely won't be as high as when you were working, but can still add up and be much more difficult to pay in one lump sum as opposed to regular payments. Also, most retirees will have at least a portion of their Social Security be subject to federal taxes yearly.

You can choose to make either quarterly tax payments or schedule regular withdrawals from Social Security, pensions, and other retirement income sources via W-4, W-4P, and W-4V forms.

Bundling Medical Expenses

If possible, try and group together as many medical expenses in a year to maximize your possible tax deduction. You can even claim expenses from prior years and then avoid claiming any in the following year or two until you can once again max out medical expenses.

You should do the same thing with charitable donations. Rather than donating every year, make several years’ worth of donations in one year to increase the value of deductions past threshold. A Donor-Advised Fund is a smart way to maximize tax savings when contributing to charities.

Use ROTH conversions to reduce future taxes

Converting significant amounts of IRA or 401k or 403b funds to ROTH status before or in retirement will help insulate all that money from all future taxes and any future tax increases.

Consult with a Tax Expert

While it's important to educate yourself about potential tax savings in retirement, the best thing you can do to lessen your tax burden is to meet with a financial advisor specializing in retirement and taxes. Tax-specific FINRA professional designations include Accredited Tax Advisor, Accredited Tax Preparer, Certified Tax Specialist, and Registered Tax Professional. Of course, CPAs can also help with ROTH conversions and other tax planning efforts.

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