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Tips to Potentially Reduce Your Tax Exposure in Retirement

3/20/2018

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​Tax season is here again. If you are recently retired or approaching retirement and haven’t budgeted for taxes, you could be in for a surprise. Many retirees assume their tax liability will go down after they leave the working world, but that’s not always the case. If you don’t prepare for taxes, you could find yourself with less disposable income than you had anticipated.

The good news is there are steps you can take today to minimize your tax exposure in retirement. Below are three such steps. You also may want to consult with a financial professional to develop action steps that are aligned with your specific needs and goals.
Convert your IRA to a Roth.
Qualified accounts like IRAs and 401(k) plans are common retirement savings vehicles. They usually offer immediate tax benefits. With a traditional IRA you can take a tax deduction for your contributions, assuming you meet income limitations. Your 401(k) contributions are deducted from your check on a pretax basis, thus reducing your taxable income.
 
Traditional IRAs and 401(k) plans also offer tax-deferred growth. This means you don’t pay taxes on growth as long as the funds are in the account. However, all distributions from these accounts are taxed as income. That could be problematic if you’re relying on a traditional IRA or 401(k) plan to provide much of your retirement income.
 
You could consider a Roth conversion to minimize the future tax burden. As the name suggests, you convert a portion of your traditional IRA funds into a Roth account. You pay taxes on the converted amount, but you won’t pay taxes on future growth or distributions, assuming you wait until age 59½ and until the Roth has been open at least five years before you take a withdrawal. A conversion may create a tax liability today, but it could also eliminate tax exposure in the future.

Use a health savings account (HSA) to pay for medical costs.
Health care is often a substantial cost item for retirees. In a recent analysis, Fidelity found that the average retired couple is likely to pay $275,000 for health care expenses in retirement.1 That includes costs such as premiums, deductibles, copays and more. If you take income from your IRA or 401(k) to pay for those costs, you could inflate your taxable income.
 
Instead, consider using a health savings account (HSA) to pay for those costs. With an HSA, you can make tax-deductible contributions, grow your funds tax-deferred and then take tax-free distributions to pay for qualified health care expenses. That could reduce the amount of taxable withdrawals you have to take from other accounts.
 
In 2018 you can contribute up to $3,450 to an HSA as an individual or $6,900 as a family. If you’re age 55 or older, you can make an additional $1,000 catch-up contribution.2 Consider maximizing your HSA contributions so you can take advantage of tax-free distributions in retirement.

Donate your RMDs to charity.
Traditional IRAs and 401(k) plans are popular in part because they allow you to defer your taxes on investment growth. However, you can’t defer those taxes forever. The IRS requires you to take minimum distributions at age 70½. These required minimum distributions (RMDs) are treated as taxable income.
 
If you’d already planned on giving money to charity, however, you could take advantage of a unique exception to reduce your taxable income. The IRS allows you to donate your RMDs to charity and avoid paying taxes on the distribution. To do so, you’ll have to set up the distribution to transfer directly to the charity without passing through your account first.
 
Ready to develop your retirement strategy? Let’s talk about it. Contact us at M&P Personal Financial Planning. We can help you analyze your needs and develop a plan. Let’s connect soon and start the conversation.


 
1https://www.fidelity.com/viewpoints/retirement/retiree-health-costs-rise
2https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/irs-sets-2018-hsa-contribution-limits.aspx 
 
 
Licensed Insurance Professional. This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice. This information has been provided by a Licensed Insurance Professional and is not sponsored or endorsed by the Social Security Administration or any government agency.
As required by the IRS, you are advised that any discussion of tax issues in this material is not intended or written to be used, and cannot be used, (a) to avoid penalties imposed under the Internal Revenue Code or (b) to promote, market or recommend to another party any transaction or matter addressed herein.
Although qualified withdrawals from a Roth IRA are tax free, when converting a Traditional IRA into a Roth IRA, the entire converted taxable amount is reportable as income in the year of conversion.
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Kevin Mahan CFA CPA/PFS
Principal
M&P Personal Financial Planning

4029 E. Broad St.
Columbus, Ohio 43213
(614) 316-3522
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