Whether you’re just easing out of the workforce or you’ve been in retirement for a few years now, making the right financial moves is critical. If you’re working with an advisor or taking a look at your finances yourself, one central goal during retirement is protecting your wealth from unnecessary taxes.
In many cases, there are ways to avoid owing more taxes - but usually, this requires proactive action beyond tax season. Below we’ll explain four tips you can utilize throughout the year to help minimize your tax obligations in retirement.
Tip #1: Don’t Ignore RMDs
A Required Minimum Distribution, or RMD, is a withdrawal that must be taken from your retirement account. These required withdrawals begin when you, the retirement plan account owner, reach age 72. The rules apply to employer-sponsored retirement plans, traditional IRA plans and Roth 401(k) accounts, but they don’t apply to Roth IRAs when the account owner is still alive.
Some IRA custodians and retirement plan administrators might find out what your RMD is for you, but the responsibility ultimately falls on you. To find out what your RMD is, the IRS provides life expectancy tables to utilize according to your circumstances. If you do not withdraw the RMD (or the correct amount), the amount not withdrawn will be taxed at 50 percent, which is why it’s critical to take your RMDs, and to calculate them correcly.1
Tip #2: Think About Income Streams
As a retiree, a portion of your income will likely come from Social Security. However, not all of your benefits are taxable, and there are ways to minimize or, at times, eliminate taxes on your Social Security benefits.
If half of your Social Security benefits in addition to your other income is higher than the base amount for your status, your benefits will be taxable. By strategically managing all of your retirement income sources (such as pension payments, dividends or part-time jobs), it’s possible to lower the portion of benefits that will be taxed. Rules regarding Social Security income taxes also vary from state to state, so always check with your state regulations to determine the best solution for you.2
Tip #3: Consider Quarterly Taxes
If you don’t have taxes withheld automatically from retirement distributions, you may need to pay estimated tax payments. Individuals who are expected to owe $1,000 or more - or those whose withholding and refundable credits are 1) less than 90 percent of the tax owed or 2) at least 100 percent of the tax on the previous year’s return - must pay estimated tax.
In some cases, even if you are not required to pay quarterly taxes, you might decide to do so. This will allow you to avoid the inconvenience of paying a large sum all at once. If you miss a payment or underpay, you may be charged a penalty.3
Tip #4: Know Your State's Tax Laws
This is especially important if you’re relocating to a new state during retirement. You should always consider the impact of a move on your financial situation, as tax laws vary according to the state. For example, some states, like Florida and New Hampshire, don’t tax on income or only tax on dividends and interest.4 That may seem attractive when you're coming from Maryland, but New Hampshire’s property taxes are high compared to the rest of the country.5 While better weather or or a more laid-back lifestyle are great reasons to move, you could decide to move to a new state in an effort to save on taxes.
Oftentimes, an individual or couple is working with a fixed amount of wealth expected to last throughout retirement. This is why it is crucial to take the right financial steps leading up to and into retirement. By working with an advisor and keeping these four tips in mind during the year, you can make sure you’re on track and not paying more than you need to.