Taxes in retirement might not be the most exciting thing to think about, but trust me, they’re worth planning for. It’s like fixing that small leak in the basement before it turns into a flood. With some proactive tax strategies, you can keep more of your money working for you and less going to Uncle Sam. Here are three solid ways to do just that.
1. Roth Conversions: Pay Now, Save Later
Imagine you are driving on a toll road that has dynamic pricing. The rates change constantly depending on time of day and traffic so you can never be totally sure what your toll will be when you exit. But let's say that the toll road also gives you the option to pay at any time while you are on the road! Well, it would be smart to pay attention to the rates and possibly "lock in" your toll when you see a good price.
For most types of retirement accounts (like a Traditional IRA or 401k), you pay the taxes when you withdraw the money in retirement. Because we don't know our future income and what future income tax rates will be, it's hard to confidently predict how much we'll owe in taxes in the future.
Now, think of a Roth conversion like paying for the toll road now. You shell out a little now (in taxes) to avoid a potentially bigger hit down the road. Here’s how it works: you transfer money from your Traditional IRA into your Roth IRA (you may even be able to do this with your 401k if the plan allows it). Yes, you’ll pay taxes now on the amount you convert, but after that, your money grows tax-free, and withdrawals can be completely tax-free too.
Why does this matter? Well, once you hit age 73, the IRS starts requiring you to take required minimum distributions (RMDs) from your Traditional IRA. Those RMDs get taxed as regular income, and if you’re not careful, they can bump you into a higher tax bracket. With a Roth IRA, there are no RMDs, which means more control over your taxable income in retirement.
Here’s a quick example: Say you’re in your 60s and have a few years before RMDs kick in. This could be the perfect window to convert some of your IRA funds to a Roth while your tax rate is lower. It’s like planting little seeds now so you can enjoy the tax-free harvest later.
2. Qualified Charitable Distributions: Give More, Save More
Let’s say you’re already giving to your church or favorite charity every year. Did you know you can do it in a way that saves you a boatload on taxes? It’s called a Qualified Charitable Distribution (QCD), and it’s a fantastic option once you turn 70½.
Here’s how it works: instead of sending money from your bank account, you donate directly from your IRA to a qualified charity. You can give up to $100,000 this way, and it counts toward your RMD for the year—but doesn’t get added to your taxable income.
Imagine your RMD is $10,000, but you already planned to give $5,000 to charity this year. With a QCD, you send that $5,000 straight to the charity and only have $5,000 left of taxable RMD income. You’ve just reduced your tax bill and supported a cause you care about. That’s what I call a win-win!
3. Health Savings Accounts: Your Secret Weapon
If you’re eligible for a Health Savings Account (HSA), this might just be your retirement secret weapon. HSA's are like a Swiss Army knife for tax savings. You get three tax perks: contributions are tax-deductible, your money grows tax-free, and you can use it tax-free for qualified medical expenses.
Think about it—healthcare is one of the biggest expenses in retirement. By building up your HSA now, you’re creating a dedicated pot of money to handle those future costs. And if you’re healthy and don’t need to use it all? No problem. After age 65, you can use HSA funds for non-medical expenses too (though you’ll pay taxes on those withdrawals, similar to a Traditional IRA).
Here’s an example: Say you contribute the maximum to your HSA every year while you’re still working and in a high-deductible health plan. By the time you retire, you could have tens of thousands of dollars set aside, ready to cover everything from prescriptions to dental work—without touching your other retirement accounts.
The Bottom Line
Here’s the thing: tax planning isn’t just about saving money. It’s about giving yourself options and flexibility in retirement. By thinking ahead and using strategies like Roth conversions, QCDs, and HSA's, you can keep more money in your pocket and have more freedom to enjoy retirement your way.
Of course, these strategies aren’t one-size-fits-all. They depend on your unique situation—your income, your goals, your family, and more. That’s why I always recommend sitting down with a financial planner and/or tax professional who can help you navigate the best options for you.
So, don’t let taxes rain on your retirement parade. If you want to dive deeper into these strategies, check out the accompanying video on the Nate Skelly CFP® YouTube page.