{"id":6118,"date":"2024-04-22T08:26:03","date_gmt":"2024-04-22T12:26:03","guid":{"rendered":"https:\/\/www.retirementplanning.net\/blog\/?p=6118"},"modified":"2024-06-19T05:47:12","modified_gmt":"2024-06-19T09:47:12","slug":"retirees-do-this-now-to-lower-next-years-tax-bill","status":"publish","type":"post","link":"https:\/\/www.retirementplanning.dev-iac.wiseradvisor.com\/blog\/retirees-do-this-now-to-lower-next-years-tax-bill\/","title":{"rendered":"Retirees – Do This Now to Lower Next Year’s Tax Bill"},"content":{"rendered":"

With every new chapter in life comes anticipation for what lies ahead. The prospect of new opportunities can be exhilarating. However, amidst this excitement, it is essential to consider financial aspects, such as taxes. Retirement, despite its allure, demands due diligence, especially regarding taxes. A significant portion of your retirement savings will be subject to taxes, which is why having a tax strategy in place can help. Tax planning should be proactive rather than reactive to ensure you are not caught off guard by a hefty bill.<\/p>\n

A\u00a0financial advisor<\/strong><\/a>\u00a0can help you understand the\u00a0various taxes\u00a0you could be subjected to\u00a0in retirement and what you can do about them right now to lower your next year\u2019s tax bill. This article will focus on\u00a0how retirees can reduce taxes\u00a0<\/strong>to ensure they get to preserve more of their savings.<\/p>\n

Below are five steps retirees can take to reduce their taxes\u00a0for the coming year:<\/h2>\n

1. Plan your Required Minimum Distributions (RMDs)<\/h3>\n

When you have money saved up for retirement in an account that you have not paid taxes on yet, like a traditional Individual Retirement Account (IRA) or 401(k), the government wants you to start taking some of that money out each year once you reach a certain age. They call this your RMD. To figure out how much you need to take out each year, you need to divide the total amount of money in your retirement account by a number\u00a0that represents\u00a0how long the government expects you to live based on your age. This number comes from a table made by the Internal Revenue Service (IRS) called the Uniform Lifetime Table. As you get older, the government wants you to take out a higher percentage of your retirement savings each year because they figure you will not live as long, so they want you to use that money sooner rather than later. The RMD\u00a0is calculated\u00a0for each separate account. So,\u00a0in case\u00a0you have more than one retirement account, you have to figure out the RMD for each account separately.<\/p>\n

If you do not withdraw your money from your traditional retirement accounts as per the IRS schedule, you will be subject to a penalty\u00a0amounting to\u00a025% of the amount not withdrawn. There is no way to avoid this penalty. However, you can lower it to 10% if you\u00a0make a withdrawal\u00a0within the next two years. Even then, you\u00a0do\u00a0lose a chunk of your savings to a penalty that could have\u00a0been used\u00a0for your retirement goals. Therefore, it is\u00a0important\u00a0to understand your RMD schedule and plan your RMDs\u00a0beforehand\u00a0to ensure you do not incur any penalties, withdraw enough money to cover your needs, and minimize your taxes.<\/p>\n

While the retirement account balances are increasing, it is important to understand that they will likely increase the distribution value in 2024, leading to a higher tax bill.<\/p>\n

Here are some strategies you can use to optimize your RMDs in 2024:<\/p>\n

a. Use a retirement calculator: <\/strong>You can use a retirement withdrawal calculator to determine your\u00a0withdrawal needs for the coming year.\u00a0The Financial Industry Regulatory Authority (FINRA), the American\u00a0Association of Retired Persons (AARP), and many other public and private organizations offer online calculators that\u00a0can be used\u00a0to determine the RMD amount for your withdrawals.\u00a0This\u00a0can help you be prepared and know your annual RMD value and taxability for the coming year. Based on these factors, you can compute your monthly income needs.<\/p>\n

b. Hire a financial advisor: <\/strong>It\u00a0is recommended\u00a0that you hire a financial advisor to understand the taxability of your withdrawals. Financial advisors can help you understand the right\u00a0strategy for making withdrawals\u00a0and ensure you optimize your RMDs to avoid penalties. They can help you understand the\u00a0tax rate for 65 years old and older,the general retiree group that makes RMDs, so that you can comprehend the impact of taxes on your withdrawals.\u00a0Even though RMDs are mandatory after\u00a0the\u00a0age\u00a0of\u00a073, you can still start withdrawing your money before that.\u00a0The minimum age for withdrawals is 59.5 years.\u00a0A financial advisor can help you devise a\u00a0withdrawal schedule that aligns with your age and\u00a0financial\u00a0needs. They can also suggest converting to a Roth account if that makes more sense for your\u00a0individual\u00a0tax situation.<\/p>\n

c. Automate your RMDs: <\/strong>Once you know how much money you should be withdrawing this year, you can set up automatic withdrawals and seamlessly set up a suitable withdrawal process. Automated withdrawals eliminate human errors, like procrastination and forgetfulness, and ensure you make the required withdrawals on time.<\/p>\n

d. Withdraw more than the recommended RMD: <\/strong>The Tax Cuts and Jobs Act,\u00a0which\u00a0was\u00a0passed\u00a0in 2017,\u00a0brought about various changes to tax rates and rules. However, many of these changes\u00a0are set\u00a0to expire at the end of 2025. When that happens, tax rates could\u00a0potentially\u00a0go up again unless new legislation\u00a0is passed\u00a0to extend or modify these changes.\u00a0If the Tax Cuts and Jobs Act provisions expire,\u00a0it\u00a0is estimated\u00a0that\u00a0taxes could increase by around $400 billion per year starting in 2026.\u00a0This potential\u00a0increase in taxes\u00a0could have significant implications for taxpayers across age groups.<\/p>\n

Given the possibility of paying higher taxes in the future, it may make sense to withdraw more of your savings now and pay a lower tax rate than a higher one\u00a0in the future. Even if you exceed your recommended RMD for the year, you can still withdraw more funds to save tax in the future when rates may be higher. However, this decision is more complicated than it seems, and a thorough evaluation\u00a0is recommended. You may consult a financial advisor<\/strong><\/a> to understand how this move aligns with your\u00a0individual\u00a0situation.<\/p>\n

2. Move to a Roth IRA<\/h3>\n

Moving to a Roth IRA<\/a> can be an effective way to lower your overall taxes. Roth IRAs are not taxed on the withdrawals made in retirement, as you have already paid tax on this money in your working years. So, all your RMDs are non-taxable after the age of 59.5 years. You can move funds from a traditional 401(k) and IRA to a Roth IRA. There is no limit on the conversion, and you can\u00a0choose to\u00a0move all your money or parts of it in batches to the new Roth account. Once your money is in a Roth account, you do not owe any future taxes\u00a0on it.\u00a0This\u00a0can eliminate paying taxes on these funds for the rest of your retirement.<\/p>\n

However,\u00a0you must keep\u00a0in mind that the conversion attracts tax. When you convert to a Roth IRA, you pay tax in the year the conversion is made. One way to minimize this is by not rolling over all your funds\u00a0at once\u00a0but making smaller rollovers over time.\u00a0This\u00a0limits your taxes for a particular year and distributes the liability. Another practical approach can be to turn over the funds right after you retire. Your income may drop in retirement, especially\u00a0if you retire\u00a0before the age of 73.\u00a0Your mandatory RMDs will not start\u00a0yet, so your\u00a0overall income for the year\u00a0will be low.\u00a0You can choose a year\u00a0where you have\u00a0a relatively low income to transfer your funds. This way, you can lower your overall tax output.<\/p>\n

3. Maintain a balance between traditional and Roth accounts<\/h3>\n

It might be prudent to balance your withdrawals, drawing from both taxed and untaxed funds. You can also consider allocating some of your money to a Roth account without entirely shifting all of your savings. The remainder can be retained in a traditional 401k\/IRA account. This\u00a0can be helpful because it gives you\u00a0flexibility when it comes to managing your taxes\u00a0in retirement.<\/p>\n

With this setup, some of your retirement funds will be taxed upon withdrawal, while others will not be taxed at all. You can withdraw funds from your traditional 401(k) account, subject to taxation, and simultaneously withdraw from your Roth account, free from taxes. This strategy has the potential to reduce your overall tax liability and promotes tax diversification.<\/p>\n