Savvy investors exert considerable effort each year minimizing their exposure to taxes. However, few investors consider the importance of early planning for tax efficiency in retirement. Many effective strategies must be implemented long before the candles at the retirement party are blown out, but opportunities still exist for those already in retirement.
Consider the following suggestions in the years prior to retirement:
Capitalize on future tax-free income. Max out Roth Individual Retirement Account (IRA) contributions if you qualify. If you don’t qualify, check into your company’s 401(k) to see if the Roth option is offered. If the rules are followed, the growth in a Roth IRA is tax-free. For taxable accounts, municipal bonds are a good option. Income from the bonds may be both federally and state tax-free.
Due to the 2010 Tax Relief Act, tax rates are still historically low, which makes a conversion of a traditional IRA to a Roth attractive. Since income limits have been removed, even high earners can convert. If the situation changes, the ability to recharacterize is an added bonus.
Use various types of accounts to achieve tax diversification, including tax-deferred, after-tax, and tax-free savings. Having options in retirement is an advantage. If tax rates increase, having only pre-tax accounts means all of your retirement distributions will be taxable.
If you’re already retired, consider the following strategies:
Estimate your tax liability at the beginning of each year and plan tax withholdings accordingly to avoid penalties and surprises. In retirement, the responsibility for paying taxes as they are owed falls on the individual. Work with an advisor and tax professional to achieve the right level of withholdings from retirement accounts. Consider making estimated quarterly tax payments.
Increase IRA distributions when you have higher deductions. In years when deductions are greatest, withdraw larger amounts from traditional IRA’s to use in years when deductions are harder to find.
Avoid short-term capital gains in taxable accounts, as they are taxed at ordinary income rates. Instead, hold assets for at least a year to recognize lower long-term capital gain rates. Actively harvest short-term losses to offset ordinary income. If you’re a mutual fund investor, consider using tax-managed funds.
The Tax Relief Act of 2010 held significant benefits for investors for 2011 and 2012. Take advantage of the opportunities while they exist. As our economy recovers, it is unlikely that the reduced rates and special provisions will continue in the future.
For more information or to find a financial planner, contact the Financial Planning Association at or 303-450-0515.
Andrea L. Blackwelder, CFP® is a registered representative offering securities through Cadaret, Grant & Co., Inc. Member FINRA/SIPC. Wisdom Wealth Strategies and Cadaret, Grant are separate entities.
